The holidays bring along an oft-repeated, whimsical warning about getting “coal in your stocking.” For investors in ETFs whose primary objective aligns with ESG (“Environmental, Social, and Governance”) strategies, the real concern is if there’s coal in an ESG portfolio.
A recent article by Bloomberg, following an investigation it conducted, takes a hard look at BlackRock’s stake in the ground for the ESG movement. The article also looks at fees and the somewhat self-fulfilling nature of how investors moving assets into BlackRock’s model portfolios drove growth in ESG. While the piece focuses on BlackRock’s prescient call for the advancement of ESG, we’re more interested in how ESGU, BlackRock’s flagship ESG portfolio finds and invests in companies that meet sustainable and responsible requirements.
Bloomberg singles out ESGU, a BlackRock ETF with a stated ESG policy that uses ratings to justify its sustainable label. Curiously, these ratings have little to do with the ESG-based impact of companies. Rather, they look at the impact to a company’s bottom line if it addresses climate change or engages in other responsible activities.
That’s an unwelcome surprise for investors who view some of these companies as among the worst when it comes to sustainability and governance. They invest in ESGU, following the fund’s ratings and hoping for better future outcomes. While it might not literally be coal in a stocking, having fossil fuel companies in an ESG portfolio isn’t that far off.
It would be like the pharmacy filling your prescription not with the drug that’s best for you, but with the one that’s best for the pharmaceutical company’s bottom line. And yes, most people would be justifiably incensed at this practice. This jarring disconnect prompts a serious question from ESG investors:
“How can I get accurate ratings information for ETFs that say they’re ESG-focused?” In other words, how “ESG” are they really?
It takes more than just looking at the fund name or ticker. The above example with ESGU illustrates this point. It also illustrates the need for an objective ratings system, one that scores an ETF based on ESG-related factors of its underlying constituents. These factors include:
- Labor Rights
- Human Rights
Scoring and weighting the ETF itself alongside constituent scoring yields useful insights. This produces a combined ESG score, considering individual “E”, “S” and “G” scores. In addition, it identifies the weights of investments in non-ESG friendly companies, like oil, weapons, defense, and nuclear, among others. Equipped with this data, investors can make better informed investment decisions regarding ESG allocations.
When financial advisors work with clients to implement investment strategies, particularly involving ESG allocations, there are three primary considerations, in our view:
- Know what you own
- Transparency into a fund or ETF, its ESG scoring (as appropriate), constituents, performance drivers and rebalancing methodology
- ESG and other thematic investments should be considered as components to the equity strategy and not independent investment strategies
- Viewing ESG as separate from the equity strategy leads to increased risk, resulting from a greater equity allocation than planned
- Pay the right price
- Understanding not just fees, but the total cost of ownership
- Not investing in complexity just for “cocktail party bias” – that is, an effort to boast about being smart and sophisticated
- Leverage existing products to participate in markets
- Staying invested to stay on track with financial plans
- Use the increasing diversity of investment products to remain invested, even if it means regularly reassessing security selection across portfolios
For advisors who have ESG-focused clients, LOGICLY provides an independent ratings service. Our ESG ratings look both at the ETF-level and the underlying, constituent level to arrive at a true ESG score. The higher the score, the greater the ESG influence on the ETF. Simple and easy to understand, without any sleight of hand.
LOGICLY gives advisors institutional-grade data and analytics to customize active or passive investment strategies that align with each client’s investment policies, timeline, and objectives.
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