ESG Exchange Traded Funds (ETFs) have seen truly explosive growth this year, with 174 new funds being launched between January and August, according to data from global analysis platform Trackinsight.
On a global basis, ETFs with an ESG label have continued to shatter new records, with $325 billion of assets under management gaining $100 billion of inflows year to date. It builds on the already blistering pace of growth witnessed in 2020, when total inflows reached $88.5 billion.
With an overwhelming number of options now on the table, even the savviest impact investor can be challenged to digest all the funds available and the ESG issues involved in them. But understanding the different types of ESG ETFs is a good place to start.
Here’s a look at four different designations of ESG ETFs, what each designation means, and some examples of funds in each category.
4 Types of ESG ETFs
Trackinsight’s analysis shows that nearly half of global ESG ETFs have tended to align themselves with one of the UN’s 17 Sustainable Development Goals (SDG). Set in 2015 and intended to be achieved by 2030, the goals are meant to foster a more sustainable future for the world.
Not every ESG ETF builds its strategy around a UN SDG, though, and even those that do take different approaches to creating a fund. Overall, there are four main approaches when it comes to ESG funds: best-in-class, exclusion, full integration, and thematic.
These ESG ETFs aim to select the most sustainable companies across sectors or leaders in certain areas. One ETF in the best-in-class category is the XZMU ETF by DWS, which aligns itself with the UN’s SDG on climate action. The fund was built by tracking the MSCI USA Low Carbon SRI Leaders NTR Index and is currently invested in 212 US companies considered to have a low carbon footprint. Microsoft is the biggest single holding in the fund, followed by Alphabet and Tesla.
Rather than including top performers, this approach excludes companies or industries that do not meet minimum standards of sustainability based on international norms. For example, the DGRA Exchange Traded Fund by WisdomTree excludes stocks that do not meet minimum ESG standards. It achieved a strong sustainability grade by excluding these stocks (the fund was given an A- by Consor), but it was not built to further any one ESG initiative. Microsoft is the largest individual holding, followed by Verizon Communications and Apple.
Full integration funds incorporate the full breadth of ESG considerations into investment selection and decision-making processes. One example is the Franklin Templeton LibertyQ Global Equity SRI ETF, which provides exposure to large and mid-cap, global, multi-factor equities with a focus on socially responsible investments. It tracks the performance of the LibertyQ Global Equity SRI Index. Among the largest holdings are Japanese electronics and semiconductors manufacturer Tokyo Electron Limited, Bank of Montreal, and US retailer Lowe’s.
Thematic ETFs focus on one specific sustainability theme, such as clean energy. The INRG ETF by iShares fits within the thematic category by exposing you to global energy ESG stocks. It’s built to track the S&P Global Clean Energy Net Total Return Index. This ETF is aligned with the UN’s Affordable and Clean Energy SDG, which seeks to ensure access to affordable, reliable, sustainable, and modern energy. Danish wind turbine manufacturer Vestas Wind Systems is the biggest single holding in the fund, followed by Danish-based wind farm operator Orsted and US solar energy company Enphase energy.
Choosing an ETF That Will Make an Impact
ESG ETFs incorporate a vast array of strategies and tend to include a large number of holdings. Just because a fund has an ESG label doesn’t mean it will necessarily be targeting investment in securities that will make a direct environmental or social impact; some funds with the ESG label are focused on avoiding companies that are believed to not meet certain ESG standards.
Choosing a thematic ESG ETF that aligns with one of the UN’s SDG goals is quite different to investing in an ESG ETF that only operates on the basis of exclusion. That said, understanding these four basic approaches to ESG ETFs can help you sort through the vast numbers of them now out there and better achieve the impact you are looking for.
Any company, security, fund or other investment identified herein is provided solely for illustrative purposes and should not be construed as a recommendation or solicitation for the purchase or sale of any such investment.