As sustainability issues play a more central role in investment conversations and managers reduce their fees, exchange-traded funds (ETFs) focused on environmental, social, and governance (ESG) factors are gaining in popularity. Read more for an overview of the state of sustainable ETFs.

What Is an ETF?

An exchange-traded fund is a passive investment vehicle structured to replicate the price performance of a given index, such as the US S&P 500. A wide range of ETFs are available to imitate the performance of indices tracking other asset types, including commodities, property, and bonds.

As the name suggests, exchange-traded funds are listed on stock exchanges themselves, so they can be bought and sold at any point during the trading day. ETFs are also generally associated with low expense ratios, since investors must pay higher fees to invest in actively managed funds. Unlike passively managed ETFs, actively managed funds run the risk of underperforming the benchmark. For these reasons, ETFs typically appeal to investors who want to gain low-cost exposure to a given index.

Sustainable ETFs mostly focus on screening out companies with lower ESG scores, rather than proactively targeting those with higher scores.

Sustainable ETFs

ESG scoring systems are quantitative, and like indices, they can be tracked by ETFs. That said, ESG is more complex than other investor preferences tracked by ETFs.

Sustainable ETFs mostly focus on screening out companies with lower ESG scores, rather than proactively targeting those with higher scores. For example, one UniCredit ETF screens out weapons, tobacco, thermal coal, and nuclear power. The ETF also includes screens that follow the United Nations Global Compact principles for human and labor rights, the environment, and business ethics. Meanwhile, passive investment giant Vanguard recently launched two ETFs that exclude stocks with lower ESG scores.

Some ETFs do target companies that create positive impact. In February 2019, BlackRock launched an electric vehicle and driving technology ETF comprising global stocks focused on manufacturing electric and autonomous vehicles, along with related firms such as battery-makers.

While some have pointed out that low-cost sustainable ETFs could attract retail investors, they also note the challenges of using ETFs as a vehicle for impact or ESG investing. “The challenge that comes with index investing is that you are a passive investor” without incentive to leverage shareholder engagement strategies, Aniket Shah of OppenheimerFunds told Knowledge@Wharton.

Want to learn more about passive investing? Read:

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