How to pick the right ESG-focused ETFs

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With investors becoming increasingly aware of how environmental, social and governance (ESG) factors are represented in their portfolios, it is not surprising that the number of sustainability-themed exchange traded funds (ETFs) has increased as asset managers respond to this shift in thinking enter .

A recent report by National Bank Financial Inc. (NBF) shows that as of August 9, there were 127 ESG-themed ETFs in Canada with more than $10 billion in total assets under management. Many of these have been introduced in the last three years.

The challenge for advisors is sorting through this growing list of funds.

Globe Advisor recently spoke to Daniel Straus, Director of ETF Research and Strategy at NBF, about the latest trends in ESG ETFs and how advisors can find suitable funds for their clients:

As your report notes, there is a growing number of ESG ETFs. So how does a consultant narrow down the options?

The main principle we try to instill in our advisors is to know what you are buying; what is inside. As analysts, we do this by sorting them into categories – such as strategy type and asset class – and then comparing them. From there it becomes a question of the underlying philosophy, like exclusions or inclusions, and how these align with the investor’s values. For example, some investors might block fossil fuels while others look for the best players in the energy sector.

It’s also worth noting that many ETFs have similar names but can have wildly different assessments of the types of companies that should be included in the portfolio. It is important for consultants to understand which methods match the wishes of their clients. Education is key: understanding sector distortions, fund holdings and concentration, screening criteria, etc.

How have ESG ETFs performed in recent years?

One area that has seen strong growth is fixed income ESG ETFs. ESG labeled bonds are a new breed of bonds and there are fixed income ESG ETFs that are heavily focused on these bonds.

Actively managed ESG ETFs are also a growing category. ESG used to be synonymous with taking the index and applying some light curtains to block out controversial industries like energy, tobacco and firearms. Now the energy subconversation alone takes up an enormous part of the mindshare around ESG.

What other advice do you have for ESG investment advisors?

If you deviate from the benchmark, depending on the ESG orientation of the portfolio, you have to keep in mind that your performance will deviate. For example, look at the difference between the performance of higher-ranked ESG companies in the technology sector in the early years of the pandemic and lower-ranked ones in sectors like energy that were declining. That has reversed in 2022, with energy doing better and technology doing worse.

A final message for advisors is that the same metrics that are important to all ETF investors are also important to ESG ETF investors: fees, liquidity and diversification. Some ESG ETFs are slightly more expensive, which could make sense if more work is put into them. Higher fees will affect performance over the long term, which is also something to consider and discuss with investors.

– This interview has been edited and shortened.

– Brenda Bouw, specially for Globe and Mail

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