What environmentally conscious ETF investors may need to know

Venturing into sustainable funds is a growing trend for environmentally conscious investors.

There are now more than 550 ESG funds, broken down by environmental, social and governance issues, according to Morningstar.

“We’re seeing an evolution of sustainable products right now,” said Jon Hale, global head of sustainability at Morningstar, in an interview Monday on CNBC’s “ETF Edge.”

Last year, investors poured an annual record $69.2 billion into ESG funds. Despite the continued high level of demand for the funds, Hale said preferences for what investors want to see from an ESG fund are “inadequate”.

“They’re not exactly inconsistent,” he said, “but it behooves asset managers to say, ‘this is generally what we want, now you need to figure out the details of it’.”

ESG funds promote a variety of causes and initiatives. Some aim to strengthen gender or racial equality, while others invest in green energy technology.

“Sustainability is complex,” Hale said. “Because it is an investment product, it must have competitive returns.”

To better ensure serious performance, ESG funds work to include the best company from all sectors, including oil and tobacco companies. Therefore, environmentally friendly companies may be excluded because their competitors perform better on certain parameters.

Hale gave the example of Tesla, which was dropped from the S&P 500 ESG Index (SPXESUP).

“There are all kinds of ESG issues that come into play when you evaluate a company,” he said. “And assess potential ESG risks to that company and the performance of its stocks.”

In the case of SPXESUP, Hale said it was Tesla’s overall risk relative to other automakers that ruled it out.

“But that same index doesn’t really take into account impact,” Hale said. “I think we need to get to a point where we combine [impact and risk]and there is a more global analysis.”

If a stock like Tesla was included in a portfolio because of its impact, Hale said there’s a case to be made for engagement — for investors to come to the table and ask for a company’s plans for reaching net zero, and changes in the business.

“It’s the same with oil companies,” Hale said. “ESG funds can make the choice. They’re not all fossil fuel-free, they’re not all-oil and gas-free.”

Most ESG funds will include oil companies. Occidental (OXY), for example, appears frequently because it scores highest on certain metrics.

“Over the past five years, during this tremendous ESG boom, generally speaking, they have outperformed traditional investments.” Hale said.

Sustainable funds outperformed their peers last year, but with a smaller margin than in previous years. Just over half of ESGs landed in the top half of their Morningstar category, with equity funds leading the way.

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