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ESG Innovation Thrives

Posted by Dan Weiskopf, ETF Professor on Aug 26, 2020 9:30:00 AM
Dan Weiskopf, ETF Professor
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Part 1: A Broad Overview about where we Stand in the U.S.
  • ESG AUMs have doubled its assets from $16.2 Billion to $33.5 Billion in 2020.
  • Alpha for ETFs targeted at Equity Returns in the US have been driven by 5 key growth companies: Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOG) and Facebook (FB).
  • We need more fixed income and non-traditional ETFs to complete the issuance of new ESG innovation.

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ESG Assets: $33.5 Billion (8/13/20)

In 2020, investor demand for ESG solutions has exploded to over $33.5 billion, with good reason. In the world of ETFs, this demand has been rewarded by alpha, low cost, and the desire to align capital with the right philosophical goals. Due in part to the BYOA trend, Assets Under Management (AUM) in the U.S. are concentrated in the Top 10 ESG ETFs, at 81% of total AUM. However, beyond the large BYOA trend, according to Bloomberg, ESGU has led the inflows with $6.990 Billion net inflows. I wrote about BYOA in ESG back in January – see article “ESG Growth: The Smart BETa On The Benefits Of Transparency.” However, in this two-part ETF Think Tank series, we thought we would take a deeper dive on performance and bring certain surprises to light.

Note that this is not just a U.S. phenomenon. ETFGI also recently reported that at the end of July 31 2020, global ETF AUM invested in ESG is now greater than $100 Billion (see link)

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Surprise #1: China can be ESG friendly

The Kraneshares MSCI China Environmental Index ETF (KGRN) provided a higher 12-month return, ending 8/21/20, than the larger broad based, China-focused ETFs with billions of AUM. This is an example of ETF innovation that may not align with the ESG definition for many people, but arguably for those looking to implement an ESG portfolio with a core satellite approach, this solution adds value as a “Core and Explore” approach. Note that KGRN only has 40 holdings and its closest overlap with any ETF is only 13%, so this allocation brings a unique set of holdings to a strategy. In this pandemic period, it may also surprise investors that Krane has one of the best performing healthcare ETFs; symbol is KURE and it too is up about 62%.

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Surprise #2: Broad Large Cap US focused ESG ETFS have Alpha because of Large Cap Technology Tilt

Driving the strong performance in broad equity US ESG ETFs is their weightings towards large cap big tech, specifically Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOG) and Facebook (FB). The broad ESG US Equity ETFs hold between 300 and 350 holdings, so the narrowing of the field using a thoughtful ESG filter has created overweighted positions towards these large growth names. The weightings of the names may be subjective according to individual index methodologies, but the message remains the same. Do good – get included in a large growing pool of capital. The surprise, however, is the broad attribution that these names have provided. Shocking as it sounds, as of August 21, 2020, AAPL is up 136%, MSFT is up 55.23%, AMZN is up 80.13%, GOOG is up 32.67% and FB is up 45.47%. No matter how you cut it, technology has led to huge alpha over the S&P 500. Most large cap growth indexes are up around 36-40% during this similar period, and the S&P 500 is up 18.43%. The below list is only the Top 30 ESG focused ETFs - there are about 60 ETFs in total.

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Surprise #3: Fixed Income and Non-Traditional Allocations are Relatively Untapped

ETF innovation in ESG, as it relates to fixed income issuance and alternatives, is relatively untapped with only 7 ETFs trading in the U.S. For this reason, look for more BYOA ESG ideas in this area. Put simply, how can a complete ESG portfolio be built without this area getting covered? The problem is the same companies driving the equity returns are cash-rich and also have an equity multiple to make acquisitions with. Nerveless, companies like Johnson and Johnson (JNJ), Visa (V) and Nvidia (NVDA) may show willingness to take advantage of low interest rates and make complimentary and or accretive deals.

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In the second part of this series, I will further explore where the alpha is coming from, where innovation should thrive (active), and ponder whether ESG could become a major driver of AUM growth in the US. Since December 31, 2019, ESG ETF AUMs have doubled from 37 Bps to over 70 Bps of aggregate ETF US AUMs. Where innovation takes this category is a huge question, and its answer will affect how the ETF market grows to $10 trillion, $30 Trillion or even $50 trillion as some pundits project.

Stay tuned for Part 2 where we explore whether the growth in ESG assets will be driven by active management or passive indexing.

Topics: Weekly Research, Structure Matters

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