Did you know that investing in companies that uphold ethical and sustainable practices can actually lead to better financial returns? In a world where the environment is constantly under threat, and social issues are becoming more important, we can now do our part as investors by investing in companies with ESG values.
There are a number of different ways to get into ESG investing. One of the best ways for passive investors is to use ETFs. In this article, we’ll take a look at some of the best ESG ETFs on the market right now.
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What is ESG Investing?
ESG stands for Environmental, Social, and Corporate Governance. ESG investing is an investment strategy that considers a firm’s environmental and social impact as well as how its governed.
If you’re new to the idea, read our ESG Investing guide to get up to speed.
What are ESG ETFs and why should you invest in them?
ETFs are investment vehicles that allow investors to gain exposure to a basket of underlying assets. You can read our ETFs beginner guide here to learn more.
When it comes to ESG investing, there are a few different types of ETFs you can choose from. For example, there are ETFs that track companies that are leaders in sustainable and responsible business practices. There are also ETFs that focus on specific themes, such as clean energy or water conservation. And finally, there are ETFs that invest in companies that score well on ESG rating systems.
With so many options, there’s sure to be an ETF that fits your investing criteria. On the flip side, having so many options can be overwhelming too.
To help you get started, we’ve rounded up some of the best ESG ETFs on the market right now.
Top 3 ESG ETFs for passive investors
There are several ESG investing strategies to meet different investment objectives and we’ll go deeper into these in the next section.
For a start, here’re the top 5 ESG ETFs by size. I used Assets Under Management (AUM) as the proxy:
iShares ESG Aware MSCI USA ETF (ESGU)
- AUM: $21.13B
- MSCI ESG Rating: AAA (9.46/10)
- Expense Ratio: 0.15%
- Index: MSCI USA Extended ESG Focus Index
- Inception Date: 12 Jan 2016
ESGU gives you exposure to large and mid-cap US stocks with favorable ESG rating.
Top 10 Holdings:
| Holding | Weightage |
| Apple Inc. | 6.91% |
| Microsoft Corporation | 5.57% |
| Amazon.com, Inc. | 3.23% |
| Tesla Inc | 1.89% |
| Alphabet Inc. Class A | 1.73% |
| Alphabet Inc. Class C | 1.68% |
| UnitedHealth Group Incorporated | 1.30% |
| Exxon Mobil Corporation | 1.12% |
| NVIDIA Corporation | 1.08% |
| JPMorgan Chase & Co. | 1.06% |
| Total Top 10 Weighting | 25.57% |
iShares ESG Aware MSCI EAFE ETF (ESGD)
- AUM: $6.1B
- MSCI ESG Rating: AAA (9.71/10)
- Expense Ratio: 0.2%
- Index: MSCI EAFE Extended ESG Focus Index
- Inception Date: 28 Jun 2016
ESGD gives you exposure to strong ESG companies in developed markets, excluding US and Canada. The fund excludes tobacco companies and certain weapon producers.
Top 10 Holdings:
| Holding | Weightage |
| Nestle S.A. | 2.45% |
| Roche Holding Ltd | 1.81% |
| ASML Holding NV | 1.69% |
| Novo Nordisk A/S Class B | 1.53% |
| Shell Plc | 1.47% |
| AstraZeneca PLC | 1.39% |
| LVMH Moet Hennessy Louis Vuitton SE | 1.27% |
| Novartis AG | 1.26% |
| Toyota Motor Corp. | 1.17% |
| TotalEnergies SE | 1.11% |
| Total Top 10 Weighting | 15.14% |
Vanguard ESG US Stock ETF (ESGV)
- AUM: $5.57B
- MSCI ESG Rating: AAA (8.66/10)
- Expense Ratio: 0.09%
- Index: FTSE US All Cap Choice Index
- Inception Date: 18 Sep 2019
ESGV gives you exposure to large, mid and small cap stocks screened for certain ESG criteria. Specific non-ESG sectors are excluded from the Vanguard ESG US stock ETF.
Top 10 Holdings:
| Holding | Weightage |
| Apple Inc. | 7.39 % |
| Microsoft Corporation | 6.14 % |
| Amazon.com, Inc. | 3.55 % |
| Tesla Inc | 2.01 % |
| Alphabet Inc. Class C | 2.01 % |
| Alphabet Inc. Class A | 1.86 % |
| UnitedHealth Group Incorporated | 1.61 % |
| Meta Platforms | 1.06 % |
| NVIDIA Corporation | 1.05 % |
| JPMorgan Chase & Co. | 1.05 % |
| Total Top 10 Weighting | 27.73% |
If you’re looking for more, we’ve compiled the top 10 MSCI AAA rated ESG ETFs here.
How to pick the right ESG ETF for your portfolio
With all the options for ESG ETFs, it can be hard to know which one is right for you.
Not all ESG ETFs are created equal. As mentioned above, different ESG ETFs are constructed differently, based on the underlying strategy used.
The best way to pick the right ESG ETF for your portfolio is to figure out what type of ESG investing strategy you may be interested in.
To help you with that, here’s a quick overview of the four common ESG investing strategies employed by ESG ETFs:
1) Exclusion Strategy
This is the easiest way to implement ESG investing. All the ETF manager needs to do, is to take an existing index and exclude any anti-ESG sectors or companies that do not meet ESG criteria.
This strategy is the easiest to understand and is suitable for those who are new to ESG investing, or investors who simply want to avoid anti-ESG sectors like fossil fuel producers or tobacco companies.
For example, the SPDR Bloomberg SASB US Corporate ESG ETF and iShares MSCI USA ESG Screen ETF rely on this strategy.
2) Thematic ESG Investing
This strategy focuses on specific sub-niches within the umbrella of ESG investing such as Renewable Energy or Clean Water. Many of these themes are part of the United Nations’ Sustainable Development Goals (SDGs) which were introduced to make the world more sustainable by 2030.
If you’re interested in thematic ESG ETFs, you should take note of the following:
- Who is the ETF provider and manager: Not all ETFs are made equal. Since this is an investment afterall, you should understand how the ETF provider selects its underlying assets and whether you can grow your money with the ETF.
- What is your cost: ETF investing comes with a fee. Do check the expense ratio and only decide to invest if you are comfortable with the cost. ETFs with a narrower niche tend to come with a higher expense ratio as more work has to be done to maintain the portfolio.
Some examples include iShares Global Clean Energy ETF and Lyxor World Water ETF.
3) Best-in-class screening
This strategy involves investing in the best companies, as ranked on ESG metrics such as greenhouse gas emissions, ethical practices, etc.
If you only want to invest in the most sustainable companies out there, this strategy is for you.
Some examples include USB MSCI World Socially Responsible ETF and iShares MSCI World SRI ETF.
4) Full Integration ESG Investing strategy
This strategy involves using ESG investing criteria to screen through stocks at every stage of the investing process; from stock selection to weightage of stocks during portfolio building.
This strategy allows you to gain exposure to the most sustainable companies, with more exposure weighted to the better ones.
Some examples include the iShares MSCI World ESG Enhanced ETF and UBS S&P500 ESG ETF.
5) Self select (DIY) ESG ETF strategy
With the availability of information online these days, you can now get lists of ETFs ranked by their ESG score. And every ETF out have been scored on popular ETF databases like etf.com or VettaFi (formerly etfdb).
If you’re not looking to invest strictly in ESG companies, you could build your own ETF portfolio by picking your ideal ETF by their ESG scores.
For example, at the point of writing, SPY has an ESG score of 8.94 while the SPDR Row Jones Industrial Average ETF (DIA) has an ESG score of 10.
If you plan to use this strategy, you should seek to understand how the ETFs are scored, as well as the investment thesis for each ETF.
Which ESG Investing strategy is for you?
Now that you understand the common ESG investing strategies ETFs employ, you would likely have a better idea of which suits your investment objectives.
Do keep in mind that these ESG investing strategies tend to optimize for sustainability first. However, your purpose in investing should be to grow your money as well.
The key to successfully building an ESG ETF portfolio, is to find the right balance between owning sustainable companies that deliver a good return for you.
Benefits of investing in ESG ETFs
There are several benefits to investing in ESG ETFs.
1) Do your part to creating a more sustainable world
Investing in companies with ESG values is a way to show your support for sustainability and responsible business practices. At the same time, you’re helping to promote sustainable and responsible business practices across the globe.
When you invest in ESG ETFs, you’re making a statement that you believe in the future of sustainable capitalism. By actively choosing to invest in sustainable companies, investors add pressure to listed companies to change for the better.
2) ESG ETFs simplify the process
ESG investing can be complex – there are many ways to evaluate a stock and even more ways to evaluate the ESG qualities of a stock.
ESG ETFs helps to simplify the process by allowing you to tap into indices and funds that are managed by professionals who do the stock picking for you.
3) Increased chances of success
Trying to pick your own ESG stocks can be risky, especially if you are not familiar with the stocks’ underlying businesses.
ESG ETFs lets you gain exposure to a basket of ESG stocks. The diversification alone helps to protect you against large drawdowns.
Risks of investing in ESG ETFs
This guide wouldn’t be complete if we do not highlight the risks of ESG investing to you. So here’re two key risks you should note:
1) Lack of standardization
The term “ESG” is still evolving and there is no one universally accepted definition of what ESG investing entails.
As a result, companies and funds may use different standards to measure the ESG qualities of stocks. Even the rating system across ESG rating agencies like MSCI, Sustainalytics, and many others vary.
This could change as ESG investing gains popularity. However, for now you should keep this in mind when picking your ESG investing vehicle.
2) May not deliver better returns
A 2019 study by the University of Chicago analyzed over 20,000 mutual funds. They found that the highest rated funds by sustainability, did not outperformed the lowest rated ones.
That said, we are still in the early days of ESG investing to draw any conclusions. Macro economical factors could play a bigger role in affecting returns in the shorter term.
Whether or not ESG investing can deliver better returns still remains to be seen.
FAQs about ESG ETFs
Here are some frequently asked questions about ESG ETFs:
Which is the best ESG ETF?
The biggest and most popular ESG ETG at the point of writing is the iShares ESG Aware MSCI USA ETF.
What is a ESG ETF?
ESG Exchange Traded Funds (ETFs) allow investors to invest in companies that comply with environmental, social and corporate governance (ESG) values.
Do your part as an investor by investing in ESG ETFs
ESG ETFs are a great way for passive investors to get into responsible investing. However, it is still early days for ESG investing.
Remember as an investor, you should always be aware of the risks and weigh your potential returns vs cost of ESG investing. Else, you may just be better off donating to charities directly.
