A six-letter acronym is transforming ethical investing in superannuation from a niche, token strategy into the mainstream.
ESG ETF: environmental, social and governance exchange-traded funds.
An ETF can be bought or sold on the Australian Securities Exchange. Its value is determined by the performance of a basket of stocks or bonds selected by a fund manager or index provider.
They often have a theme – anything from Asian technology to global robotics – and, now, environmental, social and governance (ESG), too.
ETFs are a low-cost, relatively low-risk way to access a diversified section of the sharemarket and have become wildly popular in recent years through such providers as Betashares, Vanguard and State Street. Access to the fast-growing technology sector had added fuel to the fire.
However, it is now the ESG section of the ETF market that is capturing a lot of attention as investors become more aware of climate change on its possible effects on corporate profits.
A recent Morgan Stanley report found the amount of money parked in ESG ETFs had quadrupled since January of last year and increased seven-fold since June 2017.
Rainmaker research also found demand for ESG ETFs is growing at triple the rate of the rest of Australian ETF products. Still, they make up only a tiny proportion (1.7 per cent) of the gigantic ETF market, which is worth more than $5.2 trillion.
However, $29 billion has been poured into ESG ETFs this year and researchers are forecasting their funds under management could reach $580 billion by the end of the decade.
Betashares chief executive Alex Vynokur said three years ago, it was mostly individuals running self-managed super funds who were interested in ESG ETFs. But now, major industry funds are buying in.
“What we’ve seen, it’s moved into the mainstream,” Mr Vynokur says.
Investment management giant State Street launched an ESG ETF this month that offers investors the same risk-return balance as the S&P/ASX200 Index. It is based on an index created by S&P that screens out weapons, tobacco and companies that score low on a United Nations-backed metric for sustainability.
The S&P index is constantly updated and, as of September, will also exclude companies that make more than 5 per cent of their revenue from thermal coal extraction or energy generation.
“It’s aligning to a shift towards divestment of thermal coal companies that has occurred across the ESG landscape,” State Street’s head of ETF Asia Pacific Distribution Meaghan Victor says.
Super funds have long argued divestment was a simplistic answer to a complex problem. The strategy of engagement is preferred, where funds use financial leverage to pressure companies into adopting more sustainable practices. However, this often doesn’t apply to passively held stocks, angering super fund members and undermining investment philosophies.
Ms Victor says State Street has received inquiries from some of the country’s largest super funds about the ASX-listed product and predicted growth in the sector would continue unabated.
The ASX200 ESG index continues to feature other fossil fuel producers – including Santos and Woodside Petroleum – but S&P Global’s managing director for ESG indices Reid Steadman this encouraged better practices from the companies and enabled State Street’s ETF to truly reach the mainstream.
“The popularity of that index is driven by interest and investors wanting to have ESG at the very core of their portfolio. Not as some fringe investment,” Mr Steadman says.
Only 7 per cent of ESG assets are held in ETFs according to Morgan Stanley, where this type of investing has typically been led by active managers and written off for being too expensive or not yielding high enough returns.
Specialist investors, such as Perpetual’s Trillium and Pengana’s WHEB, employ dedicated research teams to scour through a company’s every move to ensure it meets higher standards for investment. These products are often considered top-shelf and are offered to socially aware clients for a higher fee.
However, the rise of ESG ETFs looks likely to democratise ethical investing and could lead to a landscape where super funds’ default options embed ESG filters.
“In New Zealand, a fund can only qualify to be a default if it screens out certain companies that are deemed inconsistent with responsible investment principles,” Mr Vynokur says. “It would be fascinating to see if Australia follows the same path.”
Retirees could benefit in the process, Mr Vyonkur says. Last week, Rainmaker released research that found four out of the top-five best-performing personal balanced investment options for the 2019-2020 financial year were ESG funds.
Future Super topped the charts, returning 5.3 per cent, while many major super funds struggled to deliver positive results. The fund invests in bonds and equities through three of Betashares ESG ETFs.
Betashares is the market leader in ESG ETFs, with flows into the sector already 22 per cent higher than the whole of 2019 so far this year – and monthly flows up by more than 100 per cent.
“2020 is the year ESG superannuation stepped up into the big time,” Rainmaker’s head of research Alex Dunnin says.
Charlotte is a reporter for The Age.