The Role of ETFs in a Sustainable Portfolio

2020-05-19

The SFi Product Spotlight Series is an accessible overview of the available sustainable investing toolkit. This first installment reviews ESG ETFs, which we recognise as a valuable building block of a 100% sustainable portfolio. In this overview, we highlight the importance of maintaining an intentional impact strategy even within a passive investment framework.

Sustainable finance enthusiasts have been quick to celebrate the outperformance of ESG ETFs in the recent market volatility – this is not only due to the catastrophic performance of oil & gas stocks over the period, which benefited low-carbon or fossil free portfolios, but also cushioned by more supportive fund flows, which is testament to the resilience of the movement. With this key win in the bag, there is no doubt that interest in ESG, especially in ESG ETFs, will continue its exponential growth in the coming years.

Dissecting ESG Outperformance

Based on feedback from the SFi Investor Circle, we have seen outperformance for certain ESG strategies:

RS Group has shared that their ESG bank mandates have shown clear outperformance (+3% vs benchmark) in the first quarter of 2020. This is attributed not only to their explicit fossil fuel-free mandate, but also because the best-in-class approach leads to sector overweight in Healthcare, Tech, Consumer Staples, which have outperformed; in general, the focus Quality factors such as strong cashflows and balance sheets also contribute to resilience.

On the other hand, Huey Ko has seen mixed performance in equities depending on strategy; for example, one engagement fund saw a greater drawdown than her other ESG funds. She surmised that it could be due to the fund’s focus on small- and mid-cap companies with potential to improve on ESG metrics. With its strategic focus on longer term valuation enhancement and impact additionality, it is perhaps less meaningful to compare its performance with other funds over the short term.

Meanwhile, Huey also shared that both green and sustainable bonds within her bank mandate have held up well, with less volatility. Our industry checks also support this picture, with credit investors sharing that, although liquidity was similarly challenged for green and “brown” (conventional) bonds, a lot of green bonds became bid-only and did not see significant sell flow.

Of course, as a longer-term commitment, the value of a coherent sustainable investing strategy should not be judged by financial performance in one quarter. Additionally, as illustrated above, the choice of strategy will have an impact on financial risk/return – this applies not only to active investments, but for passive too.

For example, the following chart compares the performance of three global iShares ESG ETFs with their MSCI World offering: