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04 Jun 2021

What is an ESG ETF?

Written by Katie Braid
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As interest rates remain low and traditional modes of growing savings - like term deposits - offer less than exciting returns, people have begun searching for new ways to invest their savings.

Easy to access and not requiring high investment amounts, Exchange Traded Funds (ETFs) have exploded in popularity, with assets under management in global ETFs growing more than five times in two years, to over US$260 billion.

What is an ETF?

An exchange traded fund, or ETF, is a basket of assets (usually a basket of shares or bonds) that can be bought or sold in units on a stock exchange like the ASX or NZX, with the same ease as buying a single stock. One benefit of purchasing an ETF is it provides diversification, allowing you to invest in a large number of shares at once, spreading out the risk and making it less susceptible to the ups and downs of a single share price.

Another upside of this investment type is it’s easily accessible to new investors. To purchase units in an ETF, you can simply set up an online brokerage account or platform (many these days have low or no fees), load your ‘wallet’ with cash, and begin buying.

Unlike managed funds and many other investment types, ETFs do not have minimum investment amounts, though minimum amounts may be set by your online broker.

Thirdly, purchasing several hundred individual stocks would be a time-consuming feat, particularly when it comes to tax time. When purchasing ETFs however, most online brokers provide a consolidated report that you can easily provide to your accountant or the tax office.

What are ESG ETFs?

ETFs that are ethical or responsible and consider environmental, social and governance factors are commonly referred to as ‘ESG ETFs’. This category is also surging in popularity, with inflows into global ESG ETFs overtaking other ETFs for the first time in the first quarter of 2021. Since 2015, MSCI estimates ESG ETFs have grown 25 times from $6 billion to over $150 billion.

So, how can you choose the ETF that best aligns with your values and interests? We take you through some common approaches ETF providers take to embedding sustainability and ethical considerations, and highlight some ETFs certified by the Responsible Investment Association Australasia that are doing this well.

Avoiding ‘sin’ stocks (negative screening)

The most common approach used by ETF providers to construct an ‘ethical’ product is negative screening, which simply means to leave certain harmful industries or ‘sin’ stocks out of the product. Some common examples of such industries include fossil fuels, tobacco, gambling, animal cruelty and human rights abuses.

VanEck Vectors MSCI International Sustainable Equity ETF (ASX code: ESGI) is an example of a certified Responsible Investment product that screens out a huge number of issues and industries, including alcohol, animal cruelty, armaments, gambling, human rights abuses, labour rights violations, nuclear power, pornography, tobacco and fossil fuels.

Selecting the top performing funds (best-in-class screening)

Another approach is to target companies assessed to have better ‘ESG performance’ relative to their peers. Using this approach, fund managers rank companies based on a particular ESG factor, like board diversity or carbon efficiency for example.

BetaShares Global Sustainability Leaders ETF (ASX: ETHI) is a RIAA Certified fund that employs this approach, on top of screening out a range of ‘sin’ stocks including animal cruelty, armaments, gambling, tobacco and others. It ranks companies based on their ‘carbon efficiency’ (a measure of a company’s emissions relative to its revenue), and then only includes those in the top one-third of companies for carbon efficiency in the respective industry.

Using global frameworks (norms-based screening)

Norms-based screening involves assessing companies against minimum standards of business or government practice, for example as based on international norms such as those issued by the UN, ILO, OECD and NGOs.

Vanguard’s Ethically Conscious International Shares Index ETF (VESG) uses the UN Global Compact’s Ten Principles, which relate to human rights, labour, environment and anti-corruption. It assesses companies against these principles and excludes any that don’t meet the international standard.

Engaging with companies to affect change (corporate engagement)

This approach is less about how a manager chooses the companies to include in the ETF, and more about what it does to keep those companies it invests in accountable for certain behaviour or standards. Corporate engagement and shareholder action involves employing shareholder power to influence corporate behaviour, including through directly meeting with senior managers, or voting at their annual meetings.

Many ethical and responsible ETF providers like Vanguard and BetaShares do this. BetaShares has a dedicated Responsible Investment Committee who review company developments and engage with companies over ESG concerns, identifying room for improvement. This approach can be hugely influential, changing company’s policies and practices on issues like deforestation, First Nations Peoples’ rights and labour rights.

How do I choose an ETF that best aligns with my values?

It’s important to keep in mind that many ETF providers will use several approaches for the same ETF, so look at the fund’s description on its Responsible Returns profile for full detail of what they do.

Ultimately the best way to ensure an ETF is fully aligned with the specific issues that you deem important (not just what the fund’s investment manager says is ethical), is to take a good look under the hood at the companies they’re invested in. Read more about how to do this here.

The following ETFs have been certified by the Responsible Investment Association Australasia, signifying that they offer an investment style that takes into account environmental, social, governance or ethical considerations and that they adhere to the strict operational and disclosure practices required under the Responsible Investment Certification Program.

Disclaimer: The information included in this article is not a recommendation to invest in any investment products. It does not take into account your particular investment objectives, financial situation or investment needs, all of which should be considered prior to making an investment decision. You should seek professional financial advice before making any investment decision. RIAA does not hold an Australian Financial Services License (ASFL).
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About Katie Braid
Katie is the Communications and Media Coordinator for the Responsible Investment Association Australasia where she is responsible for helping build awareness of and participation in responsible, ethical and impact investing through creative communications and media campaigns.