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$30 Trillion in ESGing and They Put You in the Index

Many ESG funds and ETFs are merely closet index funds, gussied up in ESG raiment.

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You don't need a Weatherman to know which way the climate blows.

In the first two posts of my Climate War series, I introduced the idea of a massive global mobilization to address climate change (thus the war analogy) and used the oil industry as an example of how large swaths of the current economy will be left behind.

In this post, I will examine another inconvenient truth, ESG investing has been ineffective.

$30+ Trillion in ESG?

According to the Global Sustainable Investment Review (“GSIR”) 2018 Review, ESG assets stood at $30.7 trillion at the start of 2018.[1]  If true, that would put ESG assets around 38 percent of all investment assets.  The only way this number can be true is if we believe in the “big tent” theory of ESG, which basically includes any manager using ESG language.  GSIR has such a theory, stating:[2]

Sustainable investment encompasses the following activities and strategies:

  1. Negative/exclusionary screening;
  2. Positive/best-in-class screening;
  3. Norms-based screening;
  4. ESG integration;
  5. Sustainability themed investing;
  6. Impact/community investing, and;
  7. Corporate engagement and shareholder action.

While I applaud all the activities and strategies listed above, they have, thus far, not affected any noticeable change.  Certainly, the phrase “climate change” is appearing more frequently in earnings calls and 10-K filings, but that’s true about global rhetoric in general.

Chart 1:  Google Trends of “Climate Change”[3]

bantam inc jack duval PIO private investment office new york manhattan - climate change google trends chart

As can be seen in Chart 1, above, people have become increasingly more focused on climate change since 2004.

Of the seven GSIR ESG activities and strategies listed above, the first four are particularly ineffective.  By far, the most popular strategy is negative/exclusionary screening (roughly two-thirds of all ESG strategies), which excludes companies from investment according to some criteria.[4]

The problem with negative screening is that it only removes a small portion of the investment universe from consideration.  For instance, if you were to invest in an ESG S&P 500 Index fund that had used negative screening, it would have probably removed about five percent of the index, or about 25 companies.

That would leave 475 of the original 500 names.  These remaining 475 names are not suddenly “green” companies.  Most of them are doing business as usual and enjoying a little extra investment as the money that would have gone into the 25 excluded names is redistributed across the remaining 475.

While this may seem benign, it is part of a larger, two-pronged problem with ESG investments:

  • They are generally not impactful, and;
  • Their returns are undifferentiated.

Chart 2: S&P 500 v. S&P 500 ESG Index Performance[5]

bantam inc jack duval PIO private investment office new york manhattan - s&p 500 v. s&p 500 esg index

Chart 2, above, clearly shows that the price performance of the S&P 500 Index (green line) and S&P 500 ESG Index (white line), is virtually indistinguishable.

Which brings me to the next issue.

ESG Investing is Generally Index Investing

If you look at many ESG funds and ETFs, they resemble their respective benchmark, minus oil and gas, tobacco, gambling, spirts, and weapons firms.  Indeed, many are merely closet index funds, gussied up in ESG raiment.

The iShares MSCI USA ESG Select ETF (“ESG Select ETF”) is a good example.  It is successful, with $1.2 billion in AUM, and it holds only 118 names, compared to the roughly 1,000 names in the Russell 1000 Index (which includes large and mid cap stocks, the ESG Select ETF’s investment universe).  The ESG Select ETF is “thematic”, meaning it invests according to a theme and doesn’t attempt to replicate the entire market, and the Fund’s literature states that it provides:[6]

Exposure to socially responsible U.S. companies (excludes tobacco companies), (and provides) access to 100+ large- and mid-cap stocks that have been screened for positive environmental, social, and governance characteristics.

Indeed, the ESG Select ETF holdings get high ESG ratings, including a AA rating from MSCI (AAA to C scale) and an 8.5 on the MSCI ESG Quality Score (out of 10).

Unfortunately, it is a closet index fund that is virtually indistinguishable from the S&P 500.

Chart 3:  iShares MSCI USA ESG Select ETF v. S&P 500 Chart[7]

bantam inc jack duval PIO private investment office new york manhattan - ishares msci usa esg select etf v. s&p 500 chart

Does Chart 3, above, look familiar?  It looks just like Chart 2, with slightly worse performance.

Why does the ESG Select ETF have such index-like performance when it is concentrated in 118 ESG standout names?  Because it’s not concentrated in 118 ESG standout names.  In fact, it owns very few ESG names at all, and most of them are owned in very small percentages.

Table 1:  iShares MSCI USA ESG Select ETF Top 20 Holdings[8]

bantam inc jack duval PIO private investment office new york manhattan - ishares msci usa esg select etf holdings

Of the top 20 holdings in Table 1, above, only number three, Ecolab, can be said to be a real ESG name.  The rest are nowhere near ESG territory. 

It gets worse.

Table 2:  iShares MSCI USA ESG Select ETF Oil and Gas Exposures and Sector Weightings[9]

bantam inc jack duval PIO private investment office new york manhattan - ishares msci usa esg select etf sector weightings













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The sector weightings of the Select ESG ETF are virtually identical to that of the S&P 500.  As can be seen in Table 2, above, they only vary from the index by a maximum of -2.91 percent to +2.65 percent (the vertical red box).  As any layman could deduce, this is not going to change the world. 

With such trivial over- and under-weightings, the Select ESG ETF will be unable to perform differently than the benchmark S&P 500 Index, and indeed, it has not.  Unfortunately, these kinds of tepid over- and under-weights are standard in ESG mutual funds and ETFs (whether active or passive). 

Lastly, dedicated ESG investors might be shocked to learn that the ESG Select ETF owns ConoccoPhillips, Baker Hughes, Hess, TechniPMFC, and Oneok, all traditional oil and gas producers or servicing firms.  (The horizontal red box in the bottom left of Table 2, below.)

The presence of these traditional oil and gas names in an ESG fund shines a bright light on the limitations of negative screening.  While these names may be “best in class”, they are part of the problem, not part of the solution.

Negative on Negative Screening

The Select ESG ETF has only 118 holdings.  In essence, this means it has filtered out 76 percent of the S&P 500 index or 88.2 percent of the Russell 1000 Index.  However, it isn’t significantly investing in firms that will solve the problems caused by climate change.  For the most part, the 118 firms owned are just contributing less than their peers to the causes of climate change.  Very few are solving the causes of climate change or the problems caused by climate change.

These firms are in this portfolio because of their relative ESG disclosure practices, higher percentage of independent and/or female board members, etc. than their industry competitors.  While these things are all important and necessary, they are not enough.

Lastly, I want to be clear that I am not saying the ESG Select ETF, or any other ESG fund, has done no good.  What I have discussed above is actually the state of the art, and it has been for a while.  I certainly tip my cap to anyone who is thinking along these lines.  However, ESG must evolve from these blunt methods if it wants to live up to its aspirations.

In this series, I am trying to show the limitations of the old approach and to point a new way forward.

In my next post, I’ll explore what is required for ESG investing to become truly impactful and to generate differentiated returns.

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[1]      2018 Global Sustainable Investment Review; 3.  Available at: http://www.gsi-alliance.org/wp-content/uploads/2019/06/GSIR_Review2018F.pdf; Accessed February 27, 2020.

[2]      Id.

[3]      Google Trends s.v. “climate change”.  Available at: https://trends.google.com/trends/explore?date=all&geo=US&q=%22climate%20change%22; Accessed February 27, 2020.

[4]      2018 Global Sustainable Investment Review; 3.  Available at: http://www.gsi-alliance.org/wp-content/uploads/2019/06/GSIR_Review2018F.pdf; Accessed February 27, 2020.

[5]      Source: Bloomberg.

[6]      iShares MSCI USA ESG Select ETF Fact Sheet; December 31, 2019; Available at: https://www.ishares.com/us/literature/fact-sheet/susa-ishares-msci-usa-esg-select-etf-fund-fact-sheet-en-us.pdf; Accessed February 4, 2020.

[7]      Source: Bloomberg.

[8]      Source: Bloomberg.

[9]      Source: Bloomberg.

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