ETF specialist says two crucial areas let the company down
While ESG as a concept isn’t new, its application to the investment space only recently reached a tipping point. With increased attention on issues ranging from climate change to gender diversity and human rights, among others, investor interest has been clear to see in both inflows and new strategies coming to market.
“It's been a very robust couple of years,” says Marcus Berry, Vice President and ETF Specialist at Invesco Canada. “I think the pandemic really brought ESG concerns to an even higher level.”
According to Berry, flows into ESG continue to be strongest in Europe, though North America is starting to catch up. As one of the largest ESG index providers in the world, with a history going back to 2005 with some of its ESG ETFs, Invesco is a major participant in that trend; in Canada, it has 13 ESG ETFs, including 10 introduced in just the last six months.
As popular as ESG is, not everyone’s a fan. Tesla CEO Elon Musk recently criticized ESG as a “scam” after his company, a prominent leader in the transition of vehicles toward renewable energy, was dropped from the S&P 500 ESG Index, the benchmark for the Invesco S&P 500 ESG ETF (Ticker: ESG). But while Musk might feel as if his company was singled out unfairly, Berry says nothing could be further from the truth.
“They key thing to know here is that this is a passive index that follows a transparent, rules-based approach,” he says. “The index provider, S&P global, has one of the most comprehensive and robust ESG data analysis groups in the world, scoring constituents objectively based on over 1,000 data points on each company.”
According to Berry, the S&P 500 ESG index takes companies from within the S&P 500, and excludes the ones that fall into the bottom 25% in terms of ESG performance from each sector. While Tesla has managed to keep its ESG score fairly stable over the past 12 months, its peers in the automobile and components sector have improved theirs in response to calls to do better from an ESG perspective, which effectively resulted in Tesla becoming one of the laggards in its industry.
“S&P have posted on their website a full breakdown of some of their concerns around Tesla,” Berry said. “Ultimately the reason for the poor ESG score was that there was a lack of a clear carbon strategy at Tesla, as well as some questionable labour practices. Those two issues really were what hurt Tesla’s ESG ranking relative to its peer group.”
And while Musk’s reaction might make it sound as if Tesla has been banished from the universe of ESG, that’s far from the case. To illustrate the point, Berry referred to the Invesco S&P 500 ESG Tilt Index ETF (Ticker: ISTE). Like the Invesco S&P 500 ESG Index ETF, it also has the S&P 500 as its parent index, and aims to provide a similar risk-return profile while improving on the overall ESG score.
However, the Invesco ESG tilt ETF has a more forgiving methodology. Rather than excluding S&P 500 companies based on bottom-quartile ESG ranking per sector, it simply overweights or underweights stocks based on their overall ESG score.
“If you look at the number of constituents in these two indexes, the S&P 500 ESG core index has 308 names, compared to 473 in the S&P 500 ESG tilt benchmark,” Berry says. “We have initial high-level exclusions to avoid issues like tobacco, controversial weapons, and coal. But beyond that, the ESG tilt ETF just carries an underweight on lagging companies. For example, Tesla has a 1.64% weighting in the S&P 500, but it represents just 1.24% exposure in the tilt index.”
The important thing to realize, according to Berry, is that ESG isn’t a one-size-fits-all strategy, but rather a diverse set of strategies made to fit different objectives and outcomes. For some investors who see climate action as their sole priority, for example, fossil fuel-free strategies that give zero exposure to traditional energy companies would make sense. But for investors who have a broader view of ESG that also considers social and governance issues, and want their portfolios to closely replicate broad market index performance, a broad index ESG or ESG tilt strategy might make more sense.
“ESG really is a wide spectrum with many different shades of green. I think both advisors and investors need to look under the hood, understand the methodology, and appreciate the objective of any given ESG ETF,” Berry says. “Then they have to decide if it can help achieve a particular investor’s financial goals and values, which is something we really focus on enabling by providing choice.”
