The recent underperformance of many SI strategies has led some to question the merits of sustainable investing. (UBS)

For this blog, we want to discuss strategies seeking to capitalize on the SI backlash. Although many of these ETFs are newer and not available at UBS at this time, they have received media attention. Some thoughts…


• Don’t rely on product marketing/branding. We’ve written about this in the past regarding SI strategies (see Don’t treat ETFs like beers and books, published 27 May 2021). Investors should evaluate how the portfolio is constructed, the merits of the investment strategy, and whether the portfolio exposures/holdings reflect the stated strategy. Not all strategies will have the same exclusions and methods for selecting/ weighting securities. This can lead to very different portfolios.


• For ETFs tracking indices, if ESG criteria is not incorporated into the index methodology, then it does not factor into the portfolio construction process. How engaged or outspoken the ETF issuer is on ESG issues does not impact portfolio decisions. Therefore, investors do not need to pay a premium to avoid ESG considerations in their investments.


• Issuers have a fiduciary responsibility to do the best for all shareholders of a fund. Asset managers are cognizant that some shareholders care about ESG and that others do not. Therefore, when proxy voting, issuers are not going to blindly vote in favor of all ESG issues, and they are not going to vote in a way they believe will be detrimental to returns.


With respect to performance...


• Excluding companies based on their business activity, or based on their level of engagement on social/environmental issues, can help with aligning values with investments, but we do not expect these exclusions to be a driver of outperformance.


• Costs matter. Many SI and anti-ESG strategies will have higher expense ratios than ETFs tracking traditional, market cap-weighted indices. The higher the cost, the higher the barrier to outperform, or even to keep pace, with returns on those lower cost ETFs. All investors need to understand how sustainability or anti-ESG considerations drive security selection and portfolio weights to determine if the higher costs results in a portfolio that 1) sufficiently reflects their own preferences and 2) seems reasonable based on the complexity/uniqueness/merits of the strategy and versus similarly focused investments.


There are strategies that track traditional indices (those selecting and weighting securities based on market cap) and look to differentiate solely, or primarily, based on corporate governance activities such as proxy voting and engagement with management teams/boards. These ETFs can have substantial overlap with ETFs tracking traditional benchmarks, such as the S&P 500 Index. Investors need to determine if the higher fee charged, which has a direct negative impact 100% of the time, is worthwhile for the corporate governance activities, which may/may not have any impact on returns. Again, this applies to both SI and anti-ESG strategies. In Fig. 1, we show examples of two ETFs that track US large cap indices using market cap to select and weight securities. One of the ETFs is pro-ESG considerations in its corporate governance activities and the other favors profits over ESG considerations. The overlap with the S&P 500 for both ETFs is over 90%. With expense ratios of 0.05% for these two ETFs vs. 0.03% for most S&P 500 ETFs, the premium for the corporate governance activities is small. This isn't always the case though. Investors can get US energy sector exposure with an expense ratio of just 0.08%. The anti-ESG version has an expense ratio of 0.41% and the overlap is 91%. The premium paid for corporate governance activities is significant.


Finally, the recent underperformance of many SI strategies has led some to question the merits of sustainable investing. The underperformance of growth and outperformance of energy stocks has certainly been a headwind for many sustainable strategies. However, as discussed in the report 50+ shades of green: An overview of sustainable investing ETFs, published 21 July 2022, not all sustainable investing strategies have a tilt towards growth. We continue to expect a diversified SI portfolio to provide comparable returns to a traditional, non-SI oriented portfolio over the long term. We have ideas and guidance for investors building SI portfolios or looking to incorporate SI strategies into existing portfolios.


Main contributor: David Perlman, ETF Strategist, CIO Americas


Content is a product of the Chief Investment Office (CIO).


Original report - Anti-ESG ETFs, 2 November 2022.