This week, the VettaFi Voices addressed the topic of whether investors should use active or passive management for their ESG investing. Does a standardized index-based approach serve investors best, or is the flexibility of an active strategy more optimal? Also, what lies ahead for ESG in the wake of the backlash it has seen over the last year?
Todd Rosenbluth, head of ETF research: This week, Franklin Templeton acquired Putnam’s asset management business. While primarily a mutual fund company with a strong record, Putnam did dip their toe into the ETF market and ESG ETFs. These are actively managed funds, like the Putnam ESG Core Bond ETF (PCRB) and the Putnam Sustainable Leaders ETF (PLDR). I’m interested to see how Franklin incorporates these ETFs. They have a strong fixed income active ETF lineup — the Franklin Liberty U.S. Core Bond ETF (FLCB) and the Franklin Liberty Investment Grade Corporate ETF (FLCO) come to mind — but ESG has not been a focus.
Most of the ESG ETF assets are index-based, with funds like the iShares ESGU Aware MSCI USA ETF (ESGU). This ETF has seen a significant $7 billion of net outflows in 2023, as BlackRock swapped it out of a model portfolio for the iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL).
In contrast, index peer Vanguard ESG Stock ETF (ESGV), a more than $6 billion fund, has only $30 million of net outflows.
Gaining ESG Traction
Actively managed ESG ETFs have had more challenges gaining traction. I think of BNY Mellon, which offers the BNY Mellon Sustainable US Equity ETF (BKUS), the BNY Mellon Sustainable International Equity ETF (BKIS), and the BNY Mellon Sustainable Global Emerging Markets ETF (BKES), which all have limited assets.
Also, Calamos partnered with one of the most famous basketball players for its Calamos Antetokounmpo Global Sustainable Equities ETF (SROI). They have a management team with a long record of fundamental, sustainable investing. And yet, they are struggling to garner attention.
Another example is the JPMorgan Climate Change Solutions ETF (TEMP) from JPMorgan. JPMorgan has the two largest active ETFs with the JPMorgan Equity Premium Income ETF (JEPI) and the JPMorgan Ultra-Short Income ETF (JPST), but there’s not been a similar level of demand for an active climate change ETF. However, asset managers are increasingly launching active ETFs. One or more of the pillars of ESG are likely part of their traditional investment approach. So, it makes sense that they would want to showcase their expertise. However, investor education about these funds is paramount.
Despite the political backlash, ESG ETF investing is not going away. Engine No. 1 has nearly $600 million in ETF assets, with the Engine No. 1 Transform 500 ETF (VOTE) representing more than $450 million.
Defining a Good ESG Portfolio
Dave Nadig, financial futurist: ESG is one of the few things in investing that is almost entirely subjective — my definition of what a “good” ESG portfolio looks like is nearly guaranteed to be different than that of the next person. That subjectivity impacts the space in two ways.
First, we end up with a raft of product often called “ESG-lite” — funds nearly indistinguishable from their cap-weighted brethren without really teasing apart individual exposures. Those types of products absolutely have a place in the market for investors who want to “do something” but either don’t have strong opinions or are unwilling to take significant off-market risk. The second class are narrow building-block or impact-oriented strategies (a bucket I’d put something like VOTE in, Todd, or specific clean energy or net-zero type products).
Both classes of products have use cases. But I think the bigger question is what investors actually want and need. ESG is, to me the poster child for why someone needs an advisor. If you’re of reasonable means and have decided you really want to invest along your values, having an advisor to help you wade through the options and perhaps point out where a certain approach will or won’t have the desired impact and at what cost seems critical.
An Alternate ESG Approach
Heather Bell, managing editor: I used to be very skeptical of active management for ESG because my concern was that ESG-focused investors would want to know exactly what is in their portfolios. However, with ETFs, that isn’t a problem unless they’re using a nontransparent model. And even then, the Blue Tractor model lets investors see what the holdings are daily, just not the weights.
I think active is probably the better route for investors prioritizing ESG over cost. With active approaches, the fund managers can respond immediately to any unfavorable ESG developments and reduce the fund’s exposure or weighting to affected stocks. An index generally has to stick to rules and a schedule when it comes to swapping out holdings. And active managers can adjust their portfolios to reflect any information that may not be reflected in the data used by an index.
I remain an active management skeptic, as the data does not support its ability to outperform passive management consistently. But in the case of ESG investing, if the investor’s goal is more to support particular values and address concerns than to keep costs low and track closely with an index, then active management is probably the better option. Of course, the investor has to make sure that their values align with those supported by the managers, but they’d have to do that with an index too.
I’m not sure that anyone has said that passive ESG ETFs are damaging the ESG movement, so investing in those funds likely won’t have a negative effect on ESG goals — instead of paying for active management, you pay a few more basis points to track a somewhat more complex index.
Becoming “ESG Aware”
Nadig: The good news is that not only are more and more advisors becoming, at a minimum, “ESG aware,” there are actually a surprising number of advisory firms specializing specifically in helping clients navigate these waters (Bair Financial Planning, Good Investing, Boston Common, etc.). That, to me, is the “real” active here — deciding what you really want.
Rosenbluth: I’m not sure I agree ESG is that much more subjective, Dave, than smart-beta ETFs focused on quality or value. There’s disagreement whether Amazon.com or Exxon are growth stocks or a value stocks — so yes, there will be disagreement about whether Tesla is ESG-friendly or not.
Yes, Heather, the challenge with active ESG is you don’t fully know what “values” management prioritizes and if that aligns with yours. You have to trust management to make the right decisions for you.
One of the active ESG ETFs that comes to mind with more than $100 million in assets is the American Century Sustainable Equity ETF (ESGA). The team blends financial and ESG analytics to sort through large-cap equity universe.
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