Not all ESG funds are created equal

Not all ESG funds are created equal

Research fund holdings carefully


The Green Financial Revolution appears to have arrived. That’s good news for the environment, but investors need to be cautious about where they put their money. The evidence shows more people are repositioning their portfolios to include sustainable stocks and funds. These are referred to as ESG securities (environmental, social, and governance).

CNN reported in late June that EPFR, a company that tracks fund flows and asset allocation data, said that ESG securities have brought in US$61.6 billion in new money so far this year.

The death of George Floyd and the resulting worldwide protests against racial and social injustice appear to be fuelling this trend. CNN quoted Blake Pontius, a specialist in ESG investing, as saying, “Social themes were already becoming more important and relevant to investors, and that’s been accelerated and thrust into the spotlight with concerns about injustice.”

There is evidence that ESG investing can be profitable, as Reid Baker, Fundata’s Director of Analytics and Data, demonstrated in a recent article. For another concrete example, look at the energy sector. The S&P/TSX Capped Energy Index, which consists mainly of fossil fuel companies, was down 46% year-to-date as of July 15. By contrast, the S&P/TSX Renewable Energy and Clean Technology Index was up 23% over the same period.

Blackrock, the world’s largest distributor of ETFs (under the iShares brand), has made sustainability a core operating principle and is voting its shares accordingly at annual meetings. CEO Larry Fink said in a letter to corporate executives earlier this year, “Awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance. The evidence on climate risk is compelling investors to reassess core assumptions about modern finance.”

Blackrock Canada currently offers 10 ETFs based on ESG principles. A few are performing well, but most are underwater so far in 2020.

The oldest of the funds, the iShares Jantzi Social Index ETF (TSX: XEN), was down 10.4% this year as of July 17. Its long-term record is not impressive; the average annual gain since inception in 2007 is just 3.1% (to June 30).

The fund’s top holding by far is Shopify Inc. (TSX: SHOP) at 13% of total assets, which has been a big winner. But overall performance has been bogged down by the heavy weighting to financials (almost 28% of assets). Banks and insurance companies have been hard hit by the economic impact of the pandemic; the S&P/TSX Capped Financials Index is down 15.6% year to date to July 15.

The surprising thing about this ETF is its 10.8% exposure to energy. Not green energy but rather oil giants like Suncor Energy Inc. (TSX: SU), Canadian Natural Resources Ltd. (TSX: CNQ), Imperial Oil Ltd. (TSX: IMO), and Cenovus Energy Inc. (TSX: CVE). There is only one green energy company in the portfolio – Brookfield Renewable Partners LP (TSX: BEP.UN), which is classed as a utility. This may be because of market cap – most green companies in this field are small. But ESG investors who oppose fossil fuels should be aware of this.

The best performer of 2020 among Blackrock’s Canadian-based entries is the little-known iShares ESG Aware MSCI USA Index ETF (TSX: XSUS), which was showing a year-to-date total return of 7.1% as of July 17. In marked contrast to the Jantzi fund, it has only a 10% exposure to financials and a 2.5% position in energy. Again, its energy component is mainly big oil companies like ExxonMobil Corp. (NYSE: XOM). It has a small position in NextEra Energy Inc. (NYSE: NEE), but it is classed as a utility.

This fund is quite new, having been launched in March 2019. Its success to date is based on the fact that it is heavily exposed to two sectors that have performed well during the pandemic: information technology (17.6% of assets) and healthcare (14.6%). The five top holdings are Apple Inc. (NSD: AAPL), Microsoft Corp. (NSD: MSFT), Inc. (NSD: AMZN), Facebook Inc. (NSD: FB), and Alphabet Inc. (NSD: GOOG). That tells you all you need to know.

The takeaway is that if you want to get on board Blackrock’s ESG bandwagon, you need to be selective in your choice of ETFs. You should also be aware that the sustainability principles are not being applied in the energy sector to the extent many socially-responsible investors would like.

Blackrock is not the only company offering ESG funds – it’s just the one making the most noise about it. Several other companies offer ESG-based ETFs or mutual funds. One that caught my attention is the Horizons Global Sustainability Leaders Index ETF (TSX: ETHI). It seeks to replicate the performance of the Nasdaq Future Global Sustainability Leaders Index, net of expenses.

The index is designed to provide exposure to the performance of a basket of large-cap companies that are global climate change leaders (as measured by their relative carbon efficiency) and are not materially engaged in activities deemed inconsistent with responsible investment considerations. The portfolio is hedged to Canadian dollars.

The fund was launched in October 2018 and showed a one-year gain of 22.5% to June 30. Impressive, but take a closer look. Almost 70% of the fund is invested in U.S. stocks. Information technology makes up about 36% of the portfolio. Healthcare adds 17.3%, and there is no energy exposure. So this fund is riding the tech wave, which is why its numbers look good. If high tech falters, so will this fund.

In short, the top-performing Canadian-based ESG funds are riding the high-tech boom to post superior results. I am still looking for a better-balanced entry, especially one that puts more emphasis on green energy.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

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© 2020 by The Fund Library. All rights reserved.The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.