- The final months of 2021 saw ETF investors pile into ESG funds, with such products dominating flows
- Meanwhile, value ETFs have continued to lose ground
The fervour for environmental, social and governance (ESG) investments is often viewed as being of particular benefit to active managers, but its effect on fund sales can also be witnessed further afield. That’s evident enough from the world of passive funds, and exchange-traded funds (ETFs) in particular. Recent Morningstar data shows that a staggering 73 per cent of flows into European ETFs in the final quarter of 2021 went into ESG products. For 2021 as a whole, ESG funds swallowed up 51 per cent of ETF flows in Europe, up from 40 per cent in 2020 and 10 per cent in 2019.
A look at the 10 most popular equity ETFs in the fourth quarter (Q4) of 2021 reflects this, with five ESG products making an appearance. What’s notable is that all these acronym-heavy offerings – the global iShares MSCI World SRI UCITS ETF (SUWG) and the regional iShares MSCI USA SRI UCITS ETF (SUUS), Amundi MSCI Europe SRI UCITS ETF (ESRG), iShares MSCI EM SRI UCITS ETF (SUES) and Xtrackers MSCI USA ESG UCITS ETF (XESU) – follow ESG indices viewed as more stringent than some of their peers. MSCI’s SRI indices target the best 25 per cent of a given sector based on their sustainability ratings and tend to exclude more companies than peers.
Fixed income funds are also belatedly getting in on the act. Two funds with an explicit ESG focus were among the 10 most popular bond ETFs for the quarter. €21.3bn (£17.7bn) went into ESG equity ETFs on a net basis, compared with €4.3bn for ESG bond ETFs.
Corporate activity has also helped to speed up the ESG boom. “The trend in favour of sustainable investing is accelerating with a combination of new money and transfers from mainstream products into ESG versions,” notes a Morningstar commentary on the latest data. “The latter is coming about partly as a conscious decision from investors, but it is also being helped by the conversion of non-ESG ETFs into ESG versions, thus bringing all money invested in them into the ESG fold.”
ESG questions persist
Active managers with an ESG focus are sporadically required to account for holdings that have run into controversy, with Boohoo (BOO), Kingspan (KGP) and Compass (CPG) among some of the UK-listed examples of recent years. But ESG ETFs have their own critics: funds that track “light” ESG indices tend to have a great deal in common with their conventional counterparts including controversial sector allocations, while the MSCI SRI focus on the best names from different sectors means trackers hold some companies not commonly associated with sustainable investment. In the domestic market, Amundi MSCI UK IMI SRI UCITS ETF (FT1K) lists Rio Tinto (RIO) as its top holding, to give one example.
It is also worth understanding how exactly the ESG passives differ from regular trackers in major markets. Opting for the ESG versions of US and global passive funds can sometimes mean a diminished focus on the FAANG tech stocks. When it comes to iShares MSCI USA SRI UCITS ETF, not one of these stocks recently featured in its top 10 holdings list, although other market mainstays such as Tesla (US:TSLA) and Microsoft (US:MSFT) did.
That said, the differences between a regular US index tracker and its sustainable equivalent don't have to involve screening out tech entirely. The final quarter of 2021 saw the launch of Invesco NASDAQ-100 ESG UCITS ETF (NESP), an ESG-minded interpretation of the tech-heavy US index. At the time of its launch, Invesco noted that the index the fund tracks had a lower carbon intensity score than its conventional equivalent, thanks to the exclusion of utility stocks and a reduced allocation to companies with climate-related risks.
Yet its approach to the tech majors is mixed: the fund has lower exposures to Amazon.com (US:AMZN), Alphabet (US:GOOGL) and Meta Platforms (US:FB) than a conventional Nasdaq tracker, while also having less in Tesla. But it is more heavily exposed than its mainstream equivalent to Apple (US:AAPL) and Microsoft, as well as Nvidia (US:NVDA).
Investors no longer assume that they need to sacrifice top returns in the name of their morals, and it's interesting to note that some US ESG trackers have beaten their conventional peers in recent years despite having less tech exposure. iShares MSCI USA SRI UCITS ETF, for one, has outperformed its conventional MSCI USA equivalent over the past five years.
This chimes with a finding from an academic paper, “Hidden gem or fool’s gold: Can passive ESG ETFs outperform the benchmarks?” (Ariadna Dumitrescu, Jesse Jarvinen and Mohammed Zakriya, 1 August 2021). The paper’s authors compared the performance of a portfolio of conventional S&P 500 ETFs with that of their SRI-focused equivalents over the 11 years to the end of 2020. While the conventional trackers outperformed at first, the SRI funds outperformed between 2015 and 2020.
Style and substance
We have previously noted that European ETF investors appeared to lose faith in the value trade in the third quarter of 2021, and that trend has continued since then. Morningstar notes that value products “remained in the red” in the fourth quarter, suffering 'net outflows of €3.5bn. iShares Edge MSCI World Value Factor UCITS ETF (IWFV) and its US equivalent were among the 10 ETFs with the heaviest outflows in that quarter. By contrast, investors were keen to load up on quality factor funds in the same quarter. The worst-selling Morningstar fund categories in that period included global, US and European value equity funds, as well as sector funds focused on energy and industrial materials. But growth equity and tech sector ETFs proved popular.
Other notable trends continued. Thematic ETFs once again scooped up plenty of flows in the fourth quarter, and 2021 was the best ever year for this type of fund in terms of investor demand. Morningstar says that 62 per cent of the assets in thematic ETFs were in products with a link to technology, with 34 per cent in Morningstar's "physical world" category, which address the use of physical resources. These can include alternative energy funds and other portfolios focused on the transition to a low carbon world. Some 4 per cent of the thematic assets were in funds with social themes.
Looking beyond equities, accelerating consumer prices have continued to influence preferences on fixed income funds. Investors continued to favour inflation-linked and short-dated bond ETFs in the final quarter of the year.