ESG investing has taken a controversial turn in recent weeks, with some states taking aim at sustainable funds.
This month, Florida banned its $186 billion pension fund from investing based on ESG factors. And in Texas, the state comptroller accused ten financial companies of boycotting energy companies. The move could force some Texas government funds to sell shares of these companies.
BlackRock was among those named in the charge, although in a statement the company said it was not boycotting oil. But the change in sentiment has led to increased scrutiny of the composition of ESG funds.
“It’s actually relatively simple, we’re not boycotting energy companies,” Arne Noack, head of systemic investment solutions for the Americas for DWS, told Bob Pisani on CNBC’s “ETF Edge” on Wednesday.
DWS is a leading provider of ESG ETFs, including the MSCI USA ESG Leaders Equity ETF (USSG) and the S&P 500 ESG ETF (SNPE).
“[USSG and SNPE] hold between 4% and 5% of a stake in energy companies, which is in line with the S&P 500,” he added.
Noack said the USSG, for example, is largely sector-neutral relative to the benchmark MSCI USA, but only invests in companies that perform better than average from an ESG perspective.
Part of the politicization of sustainable funds stems from the question of what the products focus on and promote, and the factors taken into account when constructing them.
“ESG stands for Environmental, Social and Governance, and the focus has been on the ‘E’ part of it,” said Todd Rosenbluth, head of research at VettaFi, in an interview with “ETF Edge” on Wednesday. “If companies are too focused on climate change, and what’s happening to it.”
Rosenbluth explained that the strategies are widely diversified and evaluated based on 30 different sub-factors. Climate change is one of them, but also issues such as fair wage practices and gender diversity.
Some of the largest ESG funds have significant holdings in the energy sector. According to VettaFi, BlackRock ETFs ESGU and SUSA own 4.8% and 3.8% respectively in companies like Baker Hughes, Chevron, Exxon Mobil, Halliburton and Valero Energy. The weighting of energy stocks in these funds is in line with the S&P.
“So how can you favor ESG while still remaining exposed to these large-cap energy multinationals?” said Rosenbluth. “You can have both. These are broadly diversified products.”
The ESG industry is made up of 186 sustainable ETFs, according to VettaFi, representing 6% of all exchange-traded funds worth around $100 billion. This represents about 1.5% of the dollar value of the ETF business as a whole.
Although there have been efforts to standardize and codify what ESG means, the challenge remains how exactly to define the products.
“We’re talking about funds that have different goals that are all valid,” Mona Naqvi, global head of ESG capital markets strategy at S&P Global Sustainable1, said on CNBC’s “ETF Edge” on Wednesday. It just depends on the individual investor: some want to divest completely, that’s fine. Some want to engage companies to work with them to improve, that’s fine too. But I think painting all sustainable funds with the same brush and expecting the same results…is actually doing a disservice to the many different individual perspectives of investors and the choice we should be giving investors in a Free market.”
Another hot issue affecting the ESG industry is the greenwashing process. The term refers to when a company promotes a dubious green agenda by giving distorted impressions or misleading information about how its products are more environmentally friendly.
“I will not tell [greenwashing] is a big deal,” Noack said. “They outline the underlying methodology very clearly, and therefore make it very transparent to what extent ESG scores are used and not used.”
As an ETF fund manager, Noack said they have no discretion to deviate from the methodology and stick fully to the rules published in their prospectus.
“As a concept, it’s very easy for us all to agree on the definition [of greenwashing]Naqvi added. “But in practical terms, what does it mean and how do you know when you see it?”
Naqvi cited the example of oil majors included in low-carbon ESGs. What if the company diversifies and moves more renewable every year, she asked, or if it has more green to brown or gray revenue?
“We have problems defining ESG,” she said. “Defining greenwashing is even more difficult in many ways.”
SEC Chairman Gary Gensler has called for more clarity and specific rules regarding product labeling. Its proposed measures would prevent misleading or misleading statements by U.S. funds about their ESG qualifications and increase disclosure requirements.
“It’s a very reasonable request,” Noack explained. “It’s very much in our interest that our investors have a very clear understanding of what they’re investing in. Having standards that everyone has to adhere to, from my perspective, makes perfect sense.”
Strive recently launched its US Energy ETF (DRLL) in a bid to push back against what the company claimed was stakeholder capitalism by asset managers. The fund shows a performance close to the S&P Energy index at a higher cost.
According to Strive, the fund intends to use its shareholder engagement and proxy voting power to unlock the potential of the U.S. energy sector by rejecting the short-sighted political agendas it says have pushed companies under pressure. -invest in oil, natural gas and other forms of American energy. .
“Investors have a choice,” Rosenblum said. “If they care that their energy business is taking clean energy too far in their minds and they want to be able to be part of a strategy.”
But Rosenblum added that most investors don’t care how big companies like BlackRock vote on what to include in their funds, and that Strive is taking a more political slant to the issue.
“They call it capitalism in a different way,” he said. “This is an investment in an ETF and it should work out the way you want it to in the end.
The debate over whether the success of an ESG fund comes down to benefits or purpose remains, although they need not necessarily cancel each other out. While recent defensive moves by government entities and industry have presented a unique challenge to the future of sustainable funds, Naqvi stressed that the time horizon is critical.
“If you’re looking at a very short lead time, maybe some things seem more profitable,” she said. “But once you take that longer-term view, things like reputational considerations, potentially impending carbon taxes and pricing that make investing less profitable, those things matter.”