Why sustainable ETFs are on the rise

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The first quarter of 2021 will probably be best remembered for the Reddit rebellion, when thousands of small US retail investors piled into a failing video gaming company called GameStop. However, it might also go down in history books across the Atlantic, in Europe, as the quarter when inflows into sustainable exchange traded funds, otherwise known as ESG funds, overtook all other ETFs for the first time.

Analysts think the driving force behind both phenomena is a groundswell of public opinion against the establishment, which is seen as having exploited the underprivileged and left a trail of environmental devastation in its wake. ETF providers have seen an opportunity to sell products that might assuage those feelings of outrage and regulators have introduced policies which have helped. The result has been a jump in the number of ESG ETFs and in assets under management, which have shot up from around $45bn two years ago to more than $260bn today.

But why are investors choosing ETFs rather than other kinds of funds or single stocks even to invest according to their ESG principles? And are they really doing as much good as they think they are? Some people say ETFs are the worst thing an investor could choose if they want to have positive outcomes that is. This is because the vast majority of ETFs are for so-called passive products that follow an index of stocks or other securities. That index is a bit like a really strict shopping list. Basically when you fill your shopping basket you always have to get everything on the list and you can’t leave anything out. And even if you sell ETFs shares, you still have to have every item on the shopping list. And what this means is you can’t just get rid of a company because you suddenly find out that it sources is all its goods in Xinjiang labour camps, for example. So while index tracking ETFs can be cheaper because managers don’t have to spend the money researching the individual companies in that index, it does mean that they can end up with companies such as Boohoo, which caused a scandal last year when it was discovered that they had been exploiting their workers and employing them in very poor working conditions.

ETF providers say they engage or, in other words, talk to the companies that are in the indexes that they invest in and can persuade them to change their business practises if they are concerning. But this is nowhere near the power that an active fund manager has because an active fund manager can simply disinvest or sell any company that it transpires is engaged in unsuitable business practises.

Despite their drawbacks ESG ETFs are grabbing market share. BlackRock’s largest ever ETF launch, which debuted with 1.25bn US dollars earlier this year, aims to identify companies that would benefit from the transition to a low-carbon world. Smaller but equally compelling for the investors that wish to find ways of doing good by investing are these so-called thematic ETFs that allow niche exposures to anything from clean energy, minority empowerment, or even veganism. ESG ETFs, in short, have been packaged to allow us to invest according to our principles.

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