What are ESG ETFs?

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Many investors want to incorporate environmental, social, and governance (ESG) factors into their portfolios. In fact, nearly 80% of investors recently stated that ESG factors were important to consider in their investment decision-making, according to a PwC survey.

“Clients have been asking about ESG,” says Pat Chiefalo, Senior Vice-president, Head of ETFs & Index Strategies, Invesco Canada. “But it’s still very early days for ESG investing. As clients make more solid decisions around what type of ESG products and solutions they need, we want to meet them in the market to ensure we have what they’re looking for.”

The first step is to understand the difference between ESG and non-ESG mandates overall. Take Invesco’s S&P Core and Tilt ESG indexes. Both strategies have some initial exclusions (ie., to tobacco, controversial weapons and thermal coal, to name a few), and aim to screen out the worst ESG stocks, says the company.

But they differ in that the Core Index excludes the bottom 25% of stocks, based on an ESG score, within each sector. Meanwhile, the Tilt Index does not exclude any stocks. Instead, it overweights and underweights stocks based on ESG score. In this methodology, companies with lower ESG scores are included, but at a smaller weight.

Once you understand key differences between ESG and non-ESG mandates, then you can incorporate ESG factors into the portfolio construction process. One way to do that is through ESG ETFs. These differ from traditional market cap-rated ETFs, which reflect the broad structure of a particular geography, sector or asset class, says Chiefalo.

Instead, ESG ETFs evaluate a number of ESG factors for each security and respective benchmark, he says, so that the resulting portfolio better addresses ESG risks and opportunities for that particular exposure.

Earlier this year, Invesco expanded its ESG offerings by launching eight new ESG ETFs.

“We’re offering investors choice in how they would like to express ESG in their portfolios,” says Chiefalo. “We aren’t prescribing a one-ticket solution that we believe works. We’re engaging with clients, and, as they change their views, we’re evolving our product suite.”

Evaluating ESG ETFs 

Being mindful of ESG risks, like greenwashing, is important when evaluating a basket of securities.

“We all see the headlines,” says Chiefalo. “The risks are growing, and advisors are becoming more concerned with these elements than they were a number of years ago. It’s important for us to engage with advisors to help them find ways of mitigating and managing these types of risks.”

The key, he notes, is to work with leaders in the space.

“Be careful around companies, securities, and areas of the market that have the potential to have very high ESG risks, and cause negative outcomes in portfolios. What we’re trying to do is reduce that exposure to the greatest extent possible, so that if these outcomes were to happen, we can help with that risk.”

Chiefalo adds that it’s important to ask clients about their values, and expected risk-return outcomes.

“Also, evaluate how the portfolio has changed now that you’ve embedded ESG products in it. How does that compare to when you didn’t have any products that had ESG factors within them?”

He notes that ESG factors are only going to gain traction in the coming decades.

“If we look forward, things like climate change and social justice will continue to be top of mind for investors and markets. So as clients think about having portfolios that address some of these issues, we want to continue to evolve to better incorporate these types of metrics.”