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Advice/opinions on ethically-conscious ETFs? (aussie.zone)

submitted 4 months ago by zero_gravitas@aussie.zone to c/ausfinance@aussie.zone

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Does anyone have any advice or opinions they can share about ethically-conscious ASX ETFs?

There's a few lists around, for example:

But it's difficult to have confidence in any of these ETFs without looking into them extensively, so I was hoping I might be able to leverage the community knowledge if people here have already looked into them.

I figure many funds may be less ethical than they put on. For example, ASX:VETH excludes fossil fuels, but has a large exposure to the Big Four banks, who are big investors in fossil fuels.

Also, return figures might be misleading if a fund's ethical criteria bias its holdings towards certain industries, meaning the returns could be boosted by one-off events in those industries. For example, Motley Fool notes that ASX:ETHI is biased towards US tech stocks, including Apple and NVIDIA, and so its performance last year was boosted by the AI landrush.

Fossil fuels and weapons are my highest priorities for exclusion, if that's useful context.

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[–] MHLoppy@fedia.io 5 points 4 months ago (1 children)

I've looked at this stuff a bit in the past couple of years, so here's my echinda. I don't feel like it's easy to cover the information that you need in just a few sentences, so hopefully you don't mind me taking the liberty of writing more than that.

The first thing I'd prioritize is deciding what your goals are in an ethical/ESG ETF (henceforth just "ESG ETF") vs an equivalent "normal" ETF, and also just in general (e.g., investing in an ESG ETF vs no action). If you don't know what your goals are, you won't be able to achieve them. I would assume your goals here are some mix of financial and "ethical", otherwise you'd presumably ask about either ETFs generally (instead of ESG ETFs) or charities.

If your goal is financial out-performance, I'd personally consider it unlikely (all else being equal), though most of the people selling the ESG ETFs will suggest otherwise -- which is, of course, in their financial interest to do. The metric of success that listed companies operate under can essentially be simplified to "maximum profit", so any ESG-aligned actions that also maximize profit would already be incentivized, and anything beyond that will probably incur a performance penalty (unfortunately). Thus, if you accept that premise, logically an ESG ETF is unlikely to outperform in the long term when controlling for other factors.

Some out-performance may occur at times due to the nature of how an ESG ETF will underweight / overweight certain companies and sectors etc. As you've sort of alluded to, there tends to be somewhat of a "tech stocks" bias in some broad-market ESG ETFs I've seen, and since big tech stocks have been doing well, any ETF (ESG or otherwise) that has these stocks overweighted compared to a pure market-cap weighting will have also received that temporary out-performance benefit. The criteria that ESG ETFs use to screen out company exclusions tends to not hit on what big tech does, and tend to be harsher on e.g., the resources sector (mining etc) though it will come down the specifics of the screening process, which differ between different ETF offerings.

If your goal is to "make a difference" by sending more money in the direction of higher-ESG companies, I'd personally consider the effect very minimal. Even if you believe that raising the stock price of higher-ESG companies and/or lowering the stock price of lower-ESG companies improves the company's position in a tangible way (which there is some disagreement on), you're forgetting that you're not the only actor in the stock market. To quote my own comment from a few weeks ago:

The problem with doing this from an "activist" approach is that you're doing it in a market where the primary incentive of most of the other actors is monetary. They basically just want whatever makes the most money.

Let's say that the entire stock market is 3 companies: Ace, Brilliant, and Catastrophe, and the share price of each is $10. If a bloc of "green investors" switches their portfolios to exclude Catastrophe due to the company's environmental impact, the share price of Ace and Brilliant goes up, and the share price of catastrophe goes down. However, the majority of this effect is wiped out by other investors, who now see that Ace and Brilliant are overvalued on a purely monetary level, and Catastrophe is cheap - so the market corrects back to either the status quo (where all three are $10), or something very close to it.

You may be able to have some non-zero impact by virtue of changing how your shareholder vote is used, if your ESG ETF provider votes "better" on their ESG ETF offerings (seems unlikely), or just in general votes "better" than providers without ESG ETFs. In my experience, evaluating this is hellishly difficult as an individual retail investor because you have to sift through thousands upon thousands of shareholder votes, and I'm not personally aware of resource that solves this problem for individual investors (though that doesn't necessarily mean that one doesn't exist somewhere!). Given the uncertainty, and the little information I do have about shareholder voting done via the ESG ETF providers that I'm aware of, I think there is likely very little effect here, on average, though any provider that explicitly notes that they vote "better" is presumably more likely to have a non-zero effect on the outcome of shareholder votes if more people buy the relevant ETF(s).

(Continued in replies since there's a 5k character limit and I guess this is an extended infodump.)

[–] MHLoppy@fedia.io 3 points 4 months ago (1 children)

If your goal is simply to say "up yours" to companies that you consider the most shit and/or to sleep better at night knowing that you are less directly involved with the business practices which you don't like, you may be in luck! The criteria used by ESG ETFs is usually published and pretty clearly spelled out in their documents, so once you have a shortlist of ESG ETFs you may want to look up and actually read what the criteria specifically is instead of letting the ETF provider hand-wave it away with a smile and a "trust me bro".

As one of the articles you linked to suggests, you kind of need to decide what you personally consider "ethical", and possibly how much you're willing compromise on either financial performance (largely by virtue of higher fees) and which companies that you don't like might be in a given ETF.

I glanced through the holdings of all of the ASX-listed ESG ETFs that were on the market a couple years ago that I could find. One big problem with defining which ETFs are "ethical" is that what is "ethical" will vary person-to-person (as one of the articles you linked suggests). I personally find the ethics of big tech highly dubious (which is perhaps not surprising given that we're on the fediverse), but all the ESG ETFs I looked at include at least some big tech companies. I'm also very skeptical of junk-food mega-companies like Coca-Cola and Pepsi, because I'm pretty sure their continued drive for maximum profit on unhealthy food -- on balance -- makes the world worse. Some of the ETFs I looked do include some kind of screening for junk food, though my recollection is that it's a less common negative screen.

Fossil fuels and weapons (as you've stated as your priorities for exclusions) are quite common exclusions (so called "negative screens"), but there's still differences in how those exclusions are implemented. For example, some screening processes make decisions intra-industry / intra-sector: they screen out the "worst" companies in a given industry or sector, which may still -- as an example -- include companies with "less bad" exposure to fossil fuels. (For what it's worth, this may be desirable from the financial side because it reduces the loss of diversification that you would get if you cut out entire industries / sectors)

There's also positive screening, where an ETF will try to seek companies that are "good" -- based on whatever criteria the ETF uses. For example, an ETF with heavy positive screening is likely to overweight on companies involved in healthcare and education, on the basis that such trivialities as curing disease and teaching people to read are generally good for society (though of course there's whole separate debates about whether for-profit companies should be in charge of doing that for us, which is way beyond our scope).

In my observation, stricter screening correlates with higher fees, which makes sense, but can also impede your financial objectives. It makes me a little uneasy to quantify stuff in this way, but if the increased fees of an ESG ETF cause you to lose out on $X financial gain over the lifetime of your investment, did that $X do more good going to your ETF provider than it would have if you just gave the same amount to e.g., GiveWell?

My personal answer to that question is probably not in the case of almost all ESG ETFs (which I find a bit fucking depressing), but absent of more objective comparison it's a pretty subjective call based on your own judgement and values, so you may come to a different answer.

I'd suggest assuming that no ESG ETF will perfectly meet both your financial goals and your ethics goals, which means the decision is about what to compromise and how much, not whether to compromise.

Regarding performance, the general agreement is that, given a long enough time horizon, everything reverts to the mean; out-performance of a sector etc (when controlling for other factors like higher risk correlating with higher returns due to investors wanting compensation for that risk) is temporary. So is underperformance. Sometimes this can take a looooooooong time to change though (see: Japan). Plus since nobody knows the future, so maybe the theory doesn't hold true. In any case I wouldn't pay much attention to the past performance beyond using it as an indicator what the underlying holdings might be (higher recent performance means it might be overweight on US tech stocks, for the easy example).

(continued below)

[–] MHLoppy@fedia.io 3 points 4 months ago (1 children)

We loop back to what I first said: what are your goals?

"Basic" ESG screening (that likely "lets through" a lot of companies you're probably not fond of) can be quite cheap. For example, IESG (Australian market) has basic ESG screening and total fees of 0.11% the last time I checked, which is close to no extra cost compared to the fees of other Australian market ETFs with no ESG screening. VETH (also Australian market) has imo similarly basic screening but is at 0.16% last I checked, making me question what value it offers. In the mid-fee area of Aus market ESG ETFs you can find e.g., FAIR and GRNV with total fees of 0.36% and 0.50% the last time I checked, but with screening that's more stringent than IESG or VETH.

IWLD (World market ex-Aus) and IHWL (same thing as IWLD but hedged to AUD) have basic ESG screening and total fees of 0.09% and 0.12% the last time I checked. VESG again has screening that imo is only comparable but is up at 0.18% total fees last time I checked. On the higher end there's e.g., ETHI/HETH and ESGI are at 0.63%, 0.68%, and 0.58% respectively the last time I checked, with more stringent screens than IWLD/IHWL/VESG.

Some ESG ETFs are notably stronger on the engagement side (e.g., IMPQ - actively managed Aus small caps; I think BetaShares might do a bit more engagement on their ESG ETFs, but don't quote me on that), but this seems to strongly correlate with higher fees than peer ETFs that are otherwise comparable. IMPQ's total fees are 1.10% plus a 20% outperformance fee, though in that case you would be comparing it to other actively managed small cap ETFs, which is a more expensive type of ETF in general.

A note on fees: the big number you'll see advertised on the main ETF page online doesn't always reflect the total fees which the ETF provider estimates you'll be paying. Sometimes the number excludes stuff like transaction costs, indirect costs etc which aren't strictly "management fees" - you unfortunately have to dive into the PDS to find what the "total fee" number is (it will also vary slightly over time).

There are a couple of final things I want to underscore. First, complexity in a portfolio is generally considered to be "bad" all else being equal, as it makes it more difficult to manage and tends to correlate with higher fees which can cause significant financial drag, possibly more than you expect. Second, if you pick hastily then change your mind later, it can be expensive to do so due to capital gains. It is likely in your financial best interest to make financial decisions with a long-term time horizon. You are one of the biggest risks to the long-term performance of your portfolio by virtue of fear, greed, etc.

Recap (much of this is at least somewhat subjective):

You need to figure out what your goals are, and how much you're willing to compromise on them when they compete with each other. Unless your goals are made of wet paper, you'll almost definitely have to compromise on them - the question is just which goals and how much.
ESG ETF investing seems unlikely to out-perform even if ignoring fees, because the stock market will already try to choose whatever makes the most money.
ESG ETFs, broadly speaking, have higher fees than their non-ESG counterparts. In some cases the difference is minimal (a few basis points), but in some cases it's significant. All else being equal, higher fees will cause a drag on returns. The effect may be more significant than your intuition.
Some ESG ETF providers engage with the companies in their ETF to push them to be "better". This usually also means higher fees for you, since it's more work for them.
The past performance of an ETF is a good indicator of what the underlying holdings of the ETF are; it is not a good indicator of what future performance will be.
Generally speaking, it seems unlikely that paying ESG ETF providers higher fees is the best way to spend that extra money if your goal is to make the world better, which may mean significantly compromising on your ESG goals for the sake of not significantly compromising on your financial goals. If you're more optimistic about the positive effect of ESG ETFs, you may have to make the opposite compromise to best achieve your goals.
A simple portfolio with goals that you understand and firmly believe in is likely to better meet your long-term financial goals because you'll be comfortable sticking with it instead of constantly tinkering with it, panic-selling, etc.

Disclosure: as of writing these comments I own >0 shares of IESG, ESGI, IHWL, IMPQ. This ownership is not an endorsement or recommendation.

[–] MHLoppy@fedia.io 3 points 4 months ago (1 children)

(also since we're not financial advisers, the folks of aussie.zone probably can't give you explicit recommendations for financial products or services without causing ourselves and our benevolent dictators potential legal trouble)

[–] zero_gravitas@aussie.zone 2 points 4 months ago (1 children)

Thanks very much for the comprehensive response - I appreciate it a lot!

to sleep better at night knowing that you are less directly involved with the business practices which you don’t like

Yeah, this is approximately my motivation. Your points about actual practical impacts are interesting and helpful, though.

Lots to consider, thanks again!

[–] MHLoppy@fedia.io 3 points 4 months ago

No worries, hopefully it was helpful enough to justify possibly accidentally scaring off anybody else from answering! 😅

[–] hanrahan@slrpnk.net 3 points 4 months ago* (last edited 4 months ago)

but has a large exposure to the Big Four banks, who are big investors in fossil fuels.

I think its impossible to "invest" thematically with an ETF and avoid it.

Do you invest in a mining ETF that has a company mining Lithium that emits prodigiously to prodice the Lithium and sources finance from banks and destroys the environment doing it ?

Fossil fuels and weapons are my highest priorities for exclusion, if that's useful context.

Scope 1,2 and 3 emisisons ? Eg Brisbane Airport claim they are net zeo (from memory) but only if you ignore the massive carpark beside it and jets flying in and out.

As to weapons, do you avoid companies like Droneshied?

I get what you want to do and understand your struggle but ignoring first order effects is hard enough, once you add in 2nd and 3rd order then it's impossible .

I now stay away from banks, mining, alcohol, insurance and gambling but that's my personal choice and it still leaves me with lots of options. I invest nearly everything directly though and have since I purchased my first shares in 1989.

I'd say its impossible but do the best you can :)

Your probably better off going long companies you think do a better job then others. You don't need 100 companies, find 6 and just add to those posistions when you can.