Editor’s note: This column is part of InvestorPlace.com’s Ultimate Guide to ESG Investing.
Environmental, social and governance (ESG) principles are having a moment, but ESG investing is in the early innings of what could be a long-term megatrend.
It’s certainly possible to engage in ESG investing with single stocks. But many investors, both institutional and retail, are turning to funds to apply virtuous investing principles. Data confirm as much. At the end of July, globally listed ESG exchange-traded products (ETPs), including ETFs, topped $100 billion for the first time. What is behind this uptick in investor interest?
Laura Gonzalez, an associate professor of finance at California State University, Long Beach, told InvestorPlace that there are social and personal reasons to pursue ESG investing.
“There are two reasons to explore ESG investment opportunities. One is social responsibility and the other one is personal benefit. Personal benefit can take several forms, from health benefits to competitive returns. Research shows that ESG investment returns are becoming competitive. Therefore, even if not interested in the products or services offered, ESG investments are still an option…”
Those considering ESG investing via ETFs should note this space is rapidly evolving. In the United States, there are more than 100 ETFs that, in some form or fashion, qualify as “socially responsible.” With more high-level investors emphasizing ESG investing, change will continue to be swift. Gone are the days when simply excluding fossil fuels, alcohol, tobacco, gambling and guns cuts it as ESG.
For investors looking to mix and match some of the best ideas among prosaic and next-generation socially responsible strategies, here are some of the top funds to consider.
- Freedom 100 Emerging Markets ETF (CBOE:FRDM)
- VanEck Vectors Green Bond ETF (NYSEARCA:GRNB)
- SPDR S&P 500 ESG ETF (NYSEARCA:EFIV)
- Impact Shares NAACP Minority Empowerment ETF (NYSEARCA:NACP)
- Inspire Global Hope ETF (NYSEARCA:BLES)
- Nuveen ESG High Yield Corporate Bond ETF (NYSEARCA:NUHY)
- SPDR S&P 500 Fossil Fuel Reserves Free ETF (NYSEARCA:SPYX)
ESG Investing Picks: Freedom 100 Emerging Markets ETF (FRDM)
Expense ratio: 0.49% per year, or $49 on a $10,000 investment
The Freedom 100 Emerging Markets ETF capitalizes on some important themes, not the least of which is a slew of research confirming that virtuous investing isn’t just applicable with emerging markets assets, it is often more rewarding.
Second, FRDM is a positive break from the prosaic ESG strategy of simply excluding sin stocks and civilian arms makers. Usually, that leaves investors with a basket of stocks that may ace the “E” but lag in the other two categories.
A simple way of describing what FRDM does is saying it emphasizes human rights. That is true, but FRDM has a more involved approach. The fund uses dozens of inputs to evaluate developing economies on issues ranging from property rights to economic freedom to civil liberties and many more.
What investors get is far from the typical emerging markets ETF. FRDM excludes Brazilian, Chinese and Russian stocks, just to name a few. Additionally — and this is a positive — the fund also excludes state-controlled firms. Why is this a positive? These firms have a history of lagging private companies in emerging economies.
Not only does the FRDM strategy potentially lower volatility, its combined 46% weight to Taiwan and South Korea makes the ETF a nice diversifier for investors seeking ex-U.S. tech exposure.
VanEck Vectors Green Bond ETF (GRNB)
Expense ratio: 0.2%
For the uninitiated, the concept of green bonds is simple. They are debt sold by a company or government to fund an eco-friendly project. Compared to traditional corporate and sovereign debt markets, the green bond universe is small. But it is growing because institutional investors are demanding more of this debt.
The VanEck Vectors Green Bond ETF is the first ETF dedicated to this niche, and it follows the S&P Green Bond U.S. Dollar Select Index, which holds dollar-denominated green bonds. Gradually, GRNB should be able to capture an audience among investors because demand is higher for ESG fixed-income products. It’s just a matter of more data and education on green bonds.
“When it comes to ESG investing, whether in equities or fixed income, the issue of data remains a knotty one. While, for the time being, there are still problems around the absence of relevant data, their reliability (standardization and third-party auditing remain challenges) or both, there are also concerns around how said data should be interpreted,” notes VanEck.
With GRNB, investors get a medium-duration product with stout credit quality. Approximately 57% of its holdings are rated AAA, AA or A, implying low credit risk.
ESG Investing Picks: SPDR S&P 500 ESG ETF (EFIV)
Expense ratio: 0.1%
The SPDR S&P 500 ESG ETF is a cost-effective, traditional approach to ESG investing, relying on the standard practice of avoiding polluters, tobacco producers and gun makers. It also has the added cache of tracking the S&P 500 ESG Index, so even for investors new to virtuous concepts, there is reason for comfort.
Obviously, not all S&P 500 companies have great ESG track records. That means, over the long term, this fund will not perform in lockstep with the S&P 500.
But that is alright — on multiple accounts. First, companies with solid ESG grades are often less volatile than rivals that score poorly, subjecting investors to less volatility and small drawdowns. Second, ESG offenders are usually more controversial, forcing investors to contend with issues such as oil spills and human rights controversies. For investors looking for an overweight in technology stocks and to avoid some corporate pitfalls, EFIV is an idea that makes sense.
Impact Shares NAACP Minority Empowerment ETF (NACP)
Expense ratio: 0.76%
The Impact Shares NAACP Minority Empowerment ETF is one of the most relevant funds on this list. Look for it to start generating more buzz in the current environment. Why? NACP tracks the Morningstar Minority Empowerment Index.
That index provides exposure to U.S. companies that stand out for their “commitment to racial and ethnic diversity,” according to Morningstar. “Commitment is measured through policies, programs, and performance, as well as societal impact. Companies are judged not only on the basis of their own workforces and boards of directors, but also on their supply chains and community interactions.”
The NAACP does not help score or select fund components. Rather, Impact Shares functions as a charity and donates a percentage of its profits to the NAACP.
NACP holds 175 stocks, which are ranked by factors such as board diversity, discrimination policies, digital divide and diversity policies, among others. More than a third of the fund’s portfolio is allocated to tech and consumer cyclical names.
ESG Investing Picks: Inspire Global Hope ETF (BLES)
Expense ratio: 0.52%
The Inspire Global Hope ETF offers a biblical spin on ESG investing. Importantly, this is not a controversial idea, as highlighted by the $587 million in assets under management that Inspire has across multiple ETFs. As its name implies, BLES is a global fund. It features exposure to domestic stocks as well as developing and emerging markets fare.
BLES also takes a unique approach to virtuous investing. Avoiding alcohol, tobacco and gambling stocks is a given here, but the BLES portfolio goes further. It constructs a lineup that aligns with biblical values. Inspire ETFs, including BLES, use the Inspire Impact Score, which includes a unique set of ESG criteria. Those include avoiding companies that do business in countries that are state sponsors of terrorism, countries with poor labor practices and those with histories of Christian discrimination, among other factors.
Half of BLES’s holdings are domestic equities, 40% hail from other developed markets and the remainder are emerging markets stocks. The fund equally weights components, a methodology that limits single-stock risk. To a novice, BLES may appear gimmicky, but it is not. Academic research supports the notion that the Inspire scoring methodology can lead to long-term outperformance.
Nuveen ESG High Yield Corporate Bond ETF (NUHY)
Expense ratio: 0.35%
As noted with GRNB, there is robust demand for ESG bond products, and the Nuveen ESG High Yield Corporate Bond ETF fills a void by introducing ESG principles to the junk bond arena. Junk bonds are an arena where socially responsible standards could serve investors well over the long haul. Why? Because high-yield bonds are controversial enough without the introduction of ESG issues.
NUHY tracks the Bloomberg Barclays MSCI U.S. High Yield Very Liquid ESG Select Index, which employs many of the same, familiar strategies seen with old guard ESG equity funds. In this case, that is a plus, because avoiding companies with penchants for controversy can be useful in the credit market. Those companies could be vulnerable to not only low credit ratings, but perhaps highly speculative marks, or defaults.
The marriage of ESG and high-yield bonds does, however, have some work to do to prove to investors the combination leads to higher returns. Martin Fridson, CIO of Lehmann, Livian, Fridson Advisors, found that ESG junk bonds do not harm returns. However, the combination doesn’t necessarily juice outcomes.
“We conclude that high-yield investors are neither rewarded nor penalized for being on the side of the angels on a full array of environmental, social, and governance matters,” he writes.
ESG Investing Picks: SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX)
Expense ratio: 0.25%
The SPDR S&P 500 Fossil Fuel Reserves Free ETF is the easiest fund on this list to comprehend. Essentially, it’s the S&P 500 minus the energy sector. That sounds perfect. Not only has the energy sector long been a laggard, but its weight in the S&P 500 is declining as a result of those struggles.
Still, it cannot be ignored that over the past three year, SPYX is topping the S&P 500 by 270 basis points while displaying comparable volatility. The fund holds 488 stocks of the 505 stocks residing in the benchmark index, and it has an audience as highlighted by $652 million in assets under management.
The lay of the land with SPYX is simple. It is a great fund for investors looking to eschew fossil fuels companies, and it’s unlikely to severely lag the broader market. The rub is that if the energy sector experiences a renaissance, SPYX wouldn’t have exposure to that upside.
On the date of publication, Todd Shriber did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Todd Shriber has been an InvestorPlace contributor since 2014.