Check what's in your 'green' ETFs

While not as in vogue as last year, exchange traded funds (ETFs) with an environmental, social and governance (ESG) tilt are still going strong. 

At the height of their popularity, in the final quarter of 2021, they accounted for 73 per cent of flows into European ETFs, according to Morningstar. But by the second quarter of 2022 this had dropped to 42 per cent.

But unlike the wider sector, which overall saw €7.9bn (£6.86bn) of outflows, in the three months to September 2022 ESG-tilted ETFs were still firmly in positive territory, having gathered €14.9bn (£12.9bn) of new money. Morningstar analysts wrote that within equities “there was a clear split between the mainstream and ESG segments of the market” and “ESG-themed routes were favoured by those who wanted to invest in equity strategies during these difficult times".

This is despite the fact that European sustainable equity ETFs returned -17.6 per cent on average in the year to date, underperforming their traditional counterparts which returned -14.8 per cent, in euro returns as at 30 September 2022, according to Morningstar. 

One of the reasons for their popularity is that regardless of market movements, ESG issues remain key to institutional investors such as pension funds which have reputational risks to consider and in some cases net-zero targets to hit. 

ESG-tilted ETFs are a cheaper way to inject ethical considerations into investing than their active counterparts and cost is an especially important factor to consider in current market conditions. And there is a vast selection of ESG ETFs to choose from, meaning that you can use them to satisfy a wide range of ethical and environmental concerns.

But you would also do well to remember that like all ETFs, ESG-tilted ones are constructed according to a predetermined set of rules and left to do their thing once those are established – not the same level of care you get with active management. 

And ESG is a broad term which can mean a lot of different things. Some 'light green' ETFs simply screen out the worst offenders on ESG issues and might include companies that are not typically considered green. For example, Amundi MSCI UK IMI SRI PAB UCITS ETF (FT1K), which features in this year’s Investors’ Chronicle Top 50 ETFs list, had 3.58 per cent of its assets in mining comany Rio Tinto (RIO) as of 30 September.

Ultimately, it depends on the approach you take with your sustainability concerns as an investor. Is it a nice-to-have or a must? Are there any sectors or companies that are a no-go area for you? And do you want your investments to have a positive impact or just avoid the worst?

Regulators are working on making ESG labels more transparent for investors. Earlier this week, the Financial Conduct Authority launched a consultation on a package of rules to tackle greenwashing, including introducing three categories of labels for sustainable investment products: sustainable focus, sustainable improvers and sustainable impact. And it proposes restricting the use of words such as ESG, green or sustainable. The final rules should be published in mid 2023.

But until then, make sure you check your ethical ETFs' top holdings, sector exposures and ESG criteria so that you know what they exclude – and what they do not.

Average returns of European sustainable and traditional ETFs

Source: Morningstar Direct. Euro returns to 30 September 2022.