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Controversy weighs on sustainable ETFs

by SuperiorInvest

ESG investing has taken a controversial turn in recent weeks as some countries have focused on sustainable funds.

This month, Florida banned its $186 billion pension fund from investing according to ESG factors. And in Texas, the state comptroller charged ten financial firms with boycotting energy companies. The move could force certain Texas government funds to sell any holdings in those companies.

BlackRock was among those named in the allegations, although in a statement the company confirmed it was not boycotting oil. But the shift in sentiment has led to increased scrutiny of how ESG funds are composed.

“It’s actually relatively simple, we’re not boycotting energy companies,” said Arne Noack, director of Systemic Investment Solutions for the Americas for DWS. Bob Pisani on CNBC’ETF Edge‘ on Wednesday.

DWS is a major provider of ESG ETFs, including the MSCI USA ESG Leaders Equity ETF (USSG) and the S&P 500 ESG ETF (SNPE).

“[USSG and SNPE] they have between 4% and 5% stake in energy companies, which is in line with the S&P 500,” he added.

Noack said USSG is largely sector-neutral compared to the benchmark MSCI USA Index, for example, but only invests in companies that perform better than average from an ESG perspective.

The politicization of sustainable funds stems mainly from the question of what the products are aimed at and promoted, and from the factors that are taken into account in their construction.

“ESG stands for Environmental, Social and Governance, and the focus has been on the ‘E’ part of it,” Todd Rosenbluth, head of research at VettaFi, said in an interview with “ETF Edge” on Wednesday. “Whether companies are focusing too much on climate change and what is happening to it.”

Rosenbluth explained that the strategies are broadly diversified and evaluated based on 30 different sub-factors. These include climate change, but also issues such as fair pay and gender diversity.

Some of the largest ESG funds have significant holdings in the energy industry. According to VettaFi, BlackRock’s ETF ESGU and USA they have 4.8% and 3.8% respectively in companies such as Baker Hughes, Chevron, Exxon Mobil, Halliburton and Valero Energy. The weightings of energy stocks in these funds are in line with the S&P index.

“So how can you prioritize ESG while still having exposure to these large multinational energy companies?” Rosenbluth said. “You can have both. They are meant to be broadly diversified products.”

According to VettaFi, the ESG industry consists of 186 sustainable ETFs, representing 6% of exchange-traded funds as a whole, worth about $100 billion. That’s about 1.5% of the dollar value of the ETF business as a whole.

While efforts have been made to standardize and codify what ESG means, how to precisely define products remains a challenge.

“We’re talking about funds that have different objectives that are all valid,” Mona Naqvi, global head of ESG capital markets strategy at S&P Global Sustainable1, told CNBC’s ‘ETF Edge’ on Wednesday. It just depends on the individual investor: Some want to divest completely, that’s fine. Some want to involve companies to work with them to improve, that’s fine too. But I think to paint all sustainable funds with the same brush and expect the same results … it actually does a disservice to the many different individual perspectives that investors have and the choice we should give investors in the open market.”

Greenwashing is another hot issue affecting the ESG industry. This term refers to a situation where a company promotes a questionable green agenda by providing distorted impressions or misleading information about how its products are more environmentally friendly.

“I would not say [greenwashing] is a big issue,” Noack said. “They very clearly outline the underlying methodology and therefore very transparently show the extent to which ESG scores are being used and not being used.

As an ETF manager, Noack said they have no discretion to deviate from the methodology and fully adhere to the rules that are published in their prospectus.

“As a concept, it’s very easy for us to agree on a definition [of greenwashing]”But what does it mean in real life and how do you know it when you see it?”

Naqvi gave the example of oil majors being included under low-carbon ESG. She asked what if the company diversified and renewed more every year, or what if it had more green to brown or gray revenue?

“We have trouble defining ESG,” she said. “Defining greenwashing is in many ways even more difficult.”

SEC Chairman Gary Gensler asked for more clarity and specific rules regarding product labeling. His proposed measures would prevent US funds from making misleading or deceptive claims about their ESG qualifications and increase disclosure requirements.

“That’s a very reasonable request,” Noack explained. “It’s very much in our interest that our investors have a very clear understanding of what they’re investing in. Having standards that everyone has to adhere to makes perfect sense from my perspective.”

Strive recently launched its US Energy ETF (DRLL) in an attempt to push back what the firm claimed was stakeholder capitalism on the part of asset managers. The fund’s performance is close to the S&P Energy Index at a higher price.

According to Strive, the fund intends to use its shareholder engagement and proxy voting power to unlock the potential of the U.S. energy sector by rejecting short-sighted policy agendas that it says have caused companies to underinvest in U.S. oil, natural gas and other forms of energy. .

“Investors have a choice,” Rosenblum said. “If they care that their utility company is going too far toward clean energy and they want to be part of the strategy.”

But Rosenblum added that most investors don’t care how big companies like BlackRock vote on what to include in their funds, and that Strive puts a more political slant on the matter.

“They’re calling it capitalism in a different way,” he said. “It’s an ETF investment, and it should work the way you want it to ultimately work.

The debate over whether an ESG fund’s success boils down to profits or purpose remains, although they don’t necessarily cancel each other out. While recent defensive moves by both government entities and industry have presented a unique challenge for the future of sustainable funds, Naqvi emphasized that the time horizon is critical.

“If you’re looking at a very short time frame, maybe some things look more profitable,” she said. “But once you take that longer-term view, things like reputational considerations, potentially looming carbon taxes and prices that reduce the profitability of investments, those things matter.”

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