Even those who are sceptical about the headlong dash for investing in anything with an ethical slant should nevertheless seek to make money from the trend, I suggested earlier this month (Bearbull, 16 October 2020). It is therefore only fair – perhaps even ethical – that I should suggest some specific ways to do this.
First, however, here is a suggestion about what investors should ignore among the vast range of index-tracking exchange traded funds (ETFs) that cater to this taste – almost any fund with the initials ‘ESG’ somewhere in its name. Most readers will know ESG stands for ‘environmental, social and governance’ and, in effect, has replaced ‘ethical’ as the defining epithet of acceptable investing. The problem is, first, that the proliferation of ESG ETFs, apart from making an inedible alphabet soup, is so great as to make ESG funds that track the same regions largely indistinguishable from each other. Second, the barrier to entry to ESG status is too low. Shares in the companies comprising an ESG index are likely to be the same shares making up an overall market index minus the components of a few socially unacceptable sectors, rejected for rather arbitrary reasons. This means it remains unclear whether ESG indexes will continue outperforming the broader based indexes from which they are derived when they lose their popularity, which will happen.
Thus it makes sense to focus a little. Those attracted by the most topical – though perhaps fluffiest – part of ESG investing might be enticed by a fund brandishing the ‘inclusion and diversity’ label; for example, iShares Refinitiv Inclusion and Diversity ETF (OPEN), which tracks a 100-stock index of global companies. If so, they will also have to accept the presence of British American Tobacco (BATS) in the fund; not your normal ESG holding.
In addition, companies in the index are selected for being low on controversy. In which case, having consumer-goods suppliers Gap (US:GPS) and adidas (DE:ADS) within the fund’s top six holdings looks risky. Sure, it’s a long while since either was mentioned in headlines about exploiting third-world labour. But, almost as a by-product of how they source their leisure wear, it is always a possibility. Besides, since its launch in September 2018 the fund’s performance appears to have anticipated the accidents waiting to happen – it has gained 6 per cent compared with 30 per cent for the S&P 500 index. True, some of that underperformance is because the fund lacks tech giants, which are controversial. Even so, it’s an uninspiring performance.
More interesting is where ethical investing meets disruptive technology in the Lyxor MSCI Disruptive Technology ESG-filtered ETF (DTEC). The fund tracks an index that aims to do what it says on the can by focusing on sectors such as 3D printing, the internet of things, robotics, smart energy grids – you get the idea. The ESG filter excludes companies from the usual ‘nasty’ industries – most sectors linked to defence, ‘dirty’ energy and, of course, the most sinful of all – tobacco.
The result is a fully-replicated ETF with an investment line up of companies about which I know almost nothing. The sector allocation puts nearly 80 per cent of the fund into information technology and healthcare, with – not surprisingly – a bias towards US companies (almost 60 per cent). That said, the top 10 holdings seem to have an emphasis on low emissions and smart energy. The biggest holding is San Francisco-based Sunrun (US:RUN), an $11bn solar panels supplier that works with National Grid (NG.) in the UK, and the third biggest is a developer of hydrogen fuel cells, Plug Power (US:PLUG), of which, more in a moment. The fund has only been around since March, but the performance of its underlying MSCI index, which dates from November 2016, is encouraging. Since inception, the disruptive tech index – though without its ESG filter – has risen 113 per cent compared with a 53 per cent gain for the S&P 500.
But the one that most grabs my attention, because it is so neatly aligned with climate change, is WisdomTree Battery Solutions ETF (CHRG). The fund, which is also listed in London in dollar-denominated form (VOLT), is based on an index developed with energy consultant Wood Mackenzie whose aim is to capture those parts of energy storage with the most growth potential in a world of declining greenhouse-gas emissions. That draws on expertise from many industry sectors. Electrical components and speciality chemicals have the biggest presence, though they are followed closely – perhaps controversially – by diversified mining, which has a 15 per cent weighting. Predictably, the development of lithium-ion batteries has a big influence on the fund, although its biggest holding is the aforementioned Plug Power, a New York-based developer of hydrogen fuel cells. Currently, Plug Power’s cells power fork-lift trucks, but it is obvious where the potential in its $5.8bn market value, derived from just $300m of revenue, points to.
The WisdomTree fund was launched in February, although back-testing of the underlying index shows an average annual return of 11.6 per cent in the five years to January 2020. That compares with average returns over the same period of 10.2 per cent from the S&P 500 and just 2.4 per cent from the FTSE 100, which is encouraging, especially for those ethical investors who can ignore the inconvenient truth that much is dirty – both environmentally and politically – in the life cycle of lithium-ion batteries. Still, have you noticed how often convenience manages to trump principle? Funny that.