IROs should understand their peers’ ESG ETF ownership. But when, why and how really depends.

Getting into new indices and corresponding ETFs has traditionally come down to fundamentals such growth rate, market cap, and a host of other factors outside most IROs’ direct control. However, the birth and subsequent rise of the ESG ETF fundamentally changes that equation.

Assets in global ESG ETFs surpassed $50 billion in 2019[1]– more than doubling since the prior year. This influx makes sense: low-fee ETFs often reflect the lowest-barrier investment vehicle for millennials, a group at the forefront of investor demand for responsible investing.

This trend opens a significant opportunity for up-and-coming ESG stocks. At Clermont Partners, we have been analyzing hundreds of ESG ETFs that exclude our clients but include their competitors. And in doing so, we have made some valuable findings.  

Integrating ESG at the fund versus index level: a primer

Some believe that there is no opportunity for inclusion in an index fund if a company isn’t in the ESG index that the fund benchmarks against. But this is not always the case. It’s true that many institutions will take a non-ESG index and layer in ESG criteria to determine inclusion or weighting for the fund’s holdings, which does preclude any company not already included in the index. For example, Vanguard’s SRI Global Stock Fund selects the best ESG performers from among FTSE Developed Index constituents – precluding any company not already included in the index.

However, other ESG ETFs take a different approach, benchmarking against an established ESG-specific index, many of which represent a subset of a larger, non-ESG parent index. For example, this strategy is employed by BlackRock’s $1.8 billion iShares ESG MSCI USA Leaders ETF – one of the largest ESG ETFs today – which benchmarks against MSCI USA ESG Leaders index, which in turn is based off ESG performers within MSCI ACWI. This means that a company need only be in the parent index and have the ability to meet relevant (and often, relative) ESG criteria in order to get into the new sub index.

For companies with healthy representation in large index series such as FTSE, MSCI, Russell, S&P, or STOXX, this can present a major opportunity. However, you’ll have to be patient. Many new ESG indices are reconstituted annually or biannually, so getting in can be a relatively slow process.

In the meantime, concentrate on increasing your ESG ratings.

There is more opportunity to be had for some companies than for others

Keep in mind that pursuing ESG-integrated ETFs won’t be an impactful strategy for every company. The companies that are most likely to find meaningful and bridgeable gaps in ESG ETF ownership tend to be those whose industries are relatively well-weighted in indices and, often, have a healthy amount of index representation themselves.

But regardless of index representation or industry weightings, the single biggest factor in unlocking opportunity through ESG ETFs is an ambitious commitment to increasing ESG messaging and disclosures. Many ESG ETFs rely on Sustainalytics and MSCI ratings reports, so companies that are willing and able to make substantial improvements in their ESG scores stand to realize the biggest uplift. It is oftentimes the companies that have gone from being a low or mid performer to a top performer that ultimately see the biggest increase in ESG ETF representation.

Helping guide ESG priorities

One of the most frequent questions we get from clients on ESG projects is where to start. In other words, which ESG factors and ratings reports deserve your time and attention? An ESG ETF gap analysis can uncover the factors and reports most tied to a company’s ETF opportunity, providing one clue to the equation. 

For example, an MSCI ACWI Index constituent may find tremendous opportunities within MSCI’s ESG ETFs, offshoots of ACWI, which are most oftentimes based on criteria found within MSCI’s ESG ratings reports. Thus, focusing on the MSCI’s ESG ratings report (versus, say, Sustainalytics) would likely yield substantial gains in corresponding ESG ETF ownership – more so than for a company not included in MSCI ACWI. 

Quantify your opportunity and give your ESG project a dollar value

We hear it from IROs and even CFOs frequently: they believe that undertaking an ESG program is worth it, but they don’t have the buy-in from higher up. By conducting an ESG ETF gap analysis, you will reveal an exact dollar value of potential passive buying. This can be a valuable tool in helping management teams understand the importance of ESG initiatives. For example, in one recent analysis for a Midcap Consumer Services company, we identified nearly $20 million available in buying opportunity on the passive side alone. Presenting an opportunity in dollars can go a long way in garnering support for your ESG efforts and getting the entire top team on board with your project.

The bottom line is that savvy IROs should at least understand the upside available among passive ESG funds. With these ESG ETFs set to accelerate in number and AUM over the coming years, the untapped opportunity can be substantial. It’s worth at least taking a look to see what you stand to gain.

If you’re interested in learning more about how Clermont Partners can help improve your ESG narrative and find opportunity among ESG ETFs, contact us today.


[1] ETFGI, 2020. ETFGI is a leading independent research and consultancy firm covering trends in the global ETF/ETP ecosystem, based in London, England.