Making Sense of ESG ETFs and Impact ETFs 12/14/2020

By Herbert Blank

There are more than 100 US-listed ETFs categorized by Morningstar and others under ESG (Environmental, Social and Governance).  All have an element of attempting to align investments with personally held social values. Under the hood, there are huge differences between many and subtle huge differences between others. Its a big subject, to support this lengthy blog issue we include THREE reports.

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The Investment Company Institute uses three buckets for ESG mutual funds and ETFs, as follows:

  1. ESG inclusionary – refers to funds that use ESG information to select what stocks to include in their portfolios, such as companies with the highest ESG scores in their industry.
  2. ESG exclusionary – funds that eliminate stocks based on values, such as being fossil-free or “sin”-stock-free
  3. Impact investing – funds with a specific environmental, social or governance themes, such as green bond funds, diversity and inclusion, faith-based, resource preservation and/or clean energy funds.

These distinctions are useful for a generalized framework.  However, as we will detail, all ESG ETFs use some inclusionary and some exclusionary criteria.  This week, we compare 6 selected ETFs spanning each of the three categories. 

1. For ESG inclusionary, I chose to compare ESGU (ESG-Aware iShares MSCI USA ETF) with EFIV (SPDR S&P 500 ESG ETF).  The latter’s methodology is a very simple best-in-class approach using composite ESG scores, screening out the bottom-half of each industry sector by ESG scores while keeping the overall risk and return profile similar to that of the S&P 500.  ESGU first screens out the stocks of companies that have significant exposures to thermal coal, oil sands, tobacco, weapons, etc.  After that screen is completed, ESGU also takes a best-in-class approach with ESG scores while trying to emulate the risk and return profile of the MSCI USA Index. So, ESGU first uses exclusionary screens to winnow the universe and then is inclusionary with respect to scores.  That said, both EXCLUDE companies that fail to meet the median ESG threshold in their class.  Most empirical research published within the past 10 years consider this approach very fundamentally sound.  Those studies that found excess returns attributed to ESG data have come from eliminating the worst ESG performers while finding little distinction between the stocks with ESG scores in the top decile and those in the next three deciles.  

Among institutional investors and managers, there has been a growing consensus that ESG data quantifies future risks not reflected in financial statements. Accounting authority Baruch Lev has published research showing that 70% of the firms in the S&P 500 have their greatest assets such as reputation, brand strength, human capital and intellectual property ignored in traditional book value calculations.  ESG data directly pertain to items that can destroy these dominant assets dismissed as intangibles in traditional analyses.  Therefore, both ESGU and EFIV use a technique I call “outdexing” to eliminate the riskiest ESG stocks while closely shadowing the performance of the traditional benchmarks. In the case of ESGU in 2019 and thus far in 2020, th performance has actually surpassed the traditional benchmark.

The first glance at ValuEngine reports on ESGU and EFIV make the two look almost identical. Both get 3 Vs from Value Engine, average ratings.  They share 9 of 10 Top Ten holdings.  They both have much greater than S&P 500 weights in Technology and Finance and much lower weights in Energy and Aerospace; this is just what one would expect.  However, the over-weights and under-weights are lower for ESGU than EFIV, generally reflecting that ESGU is more diversified. Focusing on the metrics atop Page 3 reveals significant differences in how we profile each ETF.  EFIV has a lower forecast return and considerably lower ranked historical metrics than ESGU.  Methodology does matter.

The ValuEngine report for ESGU follows here, the other report on EFIV is available on

Place your cursor over the first page of the report to scroll for additional pages.

201214 VE_ESGU_260479


2. My choices for the exclusionary comparison are the iShares MSCI KLD 400 Social ETF, DSI and the SPDR® S&P® 500 Fossil Fuel Reserves Free ETF, SPYX.  The former takes classic exclusion principles from its Christian roots, avoiding alcohol, tobacco, gambling, nuclear weapons, adult entertainment, etc. The latter excludes all companies that own fossil fuel reserves.  Despite using different screens, construction methodologies and ESG ratings sources, the risk and return characteristics of DSI and its ValuEngine ranking on Page 3 appear remarkably similar to that of ESGU.  Alternatively and somewhat surprisingly, so does EFIV.  As mentioned at the outset, the difference between ETFs classified as inclusionary and those classified as exclusionary overlap along blurred lines.  Most of the ETFs in both categories attempt to be core-replacement holding with fewer ESG risks attempting to fuel better risk-return ratios.  So far, all four we’ve discussed make that case, EFIV less so than the three others.  One caveat: all four have negative year-ahead ValuEngine forecasts principally because they all have more than 30% of their weighting in large cap technology stocks, most of which we consider overvalued at this time.

Below is the ValuEngine report for DSI. The report for SPYX is available on

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3. I consider impact investing ETFs very different from the first two categories.  Most of the ESG ETFs are core-replacement holdings looking to have somewhat superior returns and somewhat less volatility than traditional benchmark indexes such as the S&P 500.  Impact ETFs are designed for those with a vision of a future that aligns with their values.  They are long-term holdings and are not intended to mirror major index return patterns on a quarterly basis.  Let’s consider the SPDR Gender Diversity ETF, SHE and the Invesco Wilder Hill Clean Energy ETF, PBW.  SHE seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector.  PBW invests in companies engaged in the business of advancement of cleaner energy and conservation.  Both are more highly rated by us than the ETFs we analyzed above. SHE is rated with 4Vs, predicted to outperform during the next 12 months.  PBW gets 5Vs, our highest rating.  

Both have much lower weightings in technology, 21% for SHE and 15% for PBW.  SHE is basically a large cap fund although not as extreme as the previous four ETFs. It has just below 90% of its weighting in large cap holdings.  SHE has a positive year-ahead forecast from us and while its momentum is not as strong as that of ESGU, DSI or SPYX, it has lower price volatility.  Diversity and inclusion research studies have demonstrated that companies with more diversity among key decision makers tend to fare better in stressful environments with better risk controls than those that do not.  SHE is an impact ETF tied to beliefs that also has characteristics consistent with a core-replacement holding.

Below is the ValuEngine report for SHE. The report for PBW is available on

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The construction of PBW is completely different.  It currently only has 44 holdings.  More than half of the holdings are midcap stocks with the remaining weights split almost evenly between large caps and small caps.  It has close to double the volatility of SHE but also has our highest rank in momentum and ranks in the 94th percentile for Alpha and the 98th percentile for forecast 1-year return.  It’s definitely not a core holding but at present it is both a holding for those who feel strongly about clean energy and a tactical Alpha play.

Finishing up on a personal note, I started working in SRI in 1987 on the team managing a Social Principles Fund. In 1996, I became the first US portfolio manager of ETFs.  Both as a product developer and author, I’ve been very involved with both ever since. Accordingly, the subject of ESG ETFs evokes great passion within me. First and foremost, I’ve always been a quant.  So, I’ve really enjoyed getting behind the numbers and shedding some light behind how similar and different ETFs lumped into the ESG category can be.

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Nevertheless, my advice on investing in ETFs remains the same. Always read the fund fact sheets to see what you are actually buying.  Then, to analyze key differences, come to ValuEngine with more than 500 ETF reports. Its free for the first two weeks, go HERE.

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