The green financial revolution appears to have arrived. That’s good news for the environment, but investors need to be cautious about where they put their money.
The evidence shows more people are repositioning their portfolios to include sustainable stocks and funds. These are referred to as ESG (environmental, social and governance) securities.
EPFR, a company that tracks fund flows and asset allocation data, said that ESG securities have brought in US$61.6-billion in new money so far this year, according to a report in late June by CNN.
The death of George Floyd and the resulting worldwide protests against racial and social injustice appear to be fuelling this trend. CNN quoted Blake Pontius, a specialist in ESG investing, as saying: “Social themes were already becoming more important and relevant to investors, and that’s been accelerated and thrust into the spotlight with concerns about injustice.”
There is evidence that ESG investing can be profitable. Look at the energy sector. The S&P/TSX Capped Energy Index, which consists mainly of fossil fuel companies, was down 48.5 per cent year to date. By contrast, the S&P/TSX Renewable Energy and Clean Technology Index was up 21.2 per cent over the same period.
BlackRock Inc., the world’s largest distributor of ETFs (iShares), has made sustainability a core operating principle and is voting its shares accordingly at annual meetings. “Awareness is rapidly changing and I believe we are on the edge of a fundamental reshaping of finance,” Larry Fink, BlackRock’s chief executive, said in a letter to corporate executives earlier this year. “The evidence on climate risk is compelling investors to reassess core assumptions about modern finance.”
BlackRock Canada currently offers 10 ETFs based on ESG principles. A few are performing well, but most are underwater so far in 2020.
The oldest of the funds, the iShares Jantzi Social Index ETF (XEN-T), was down 10.9 per cent this year. Its long-term record is not impressive; the average annual gain since inception in 2007 is just 3.1 per cent (to June 30).
The fund’s top holding by far is Shopify Inc. (13 per cent of total assets), which has been a big winner. But overall performance has been bogged down by the heavy weighting to financials (almost 28 per cent of assets). Banks and insurance companies have been hit hard by the economic impact of the pandemic; the S&P/TSX Capped Financials Index is down 16 per cent year to date.
The surprising thing about this ETF is its 10.8-per-cent exposure to energy. Not green energy, but rather oil giants such as Suncor Energy Inc., Canadian Natural Resources Ltd., Imperial Oil Ltd. and Cenovus Energy Inc. There is only one green energy company in the portfolio – Brookfield Renewable Partners LP, which is classed as a utility. This may be because of a market cap – most green companies in this field are small. But ESG investors who oppose fossil fuels should be aware of this.
The best performer of 2020 among BlackRock’s Canadian-based entries is the little-known iShares ESG Aware MSCI USA Index ETF (XSUS-T), which was showing a year-to-date total return of 6.9 per cent. In marked contrast to the Jantzi fund, it has only a 10-per-cent exposure to financials and a 2.5-per-cent position in energy. Again, its energy component is mainly big oil companies such as Exxon Mobil Corp. It has a small position in NextEra Energy Inc., which is focused on renewables, but it is classed as a utility.
This fund is quite new, having been launched in March, 2019. Its success to date is based on the fact it is heavily exposed to two sectors that have performed well during the pandemic: information technology (17.6 per cent of assets) and health care (14.6 per cent). The five top holdings are Apple Inc., Microsoft Corp., Amazon.com Inc., Facebook Inc. and Alphabet Inc. That tells you all you need to know.
The takeaway is that if you want to get on board BlackRock’s ESG bandwagon, you need to be selective in your choice of ETFs. You should also be aware that the sustainability principles are not being applied in the energy sector to the extent many socially responsible investors would like.
BlackRock is not the only company offering ESG funds – it’s just the one making the most noise about it. Several other companies offer ESG-based ETFs or mutual funds. One that caught my attention is the Horizons Global Sustainability Leaders Index ETF (ETHI-T). It seeks to replicate the performance of the Nasdaq Future Global Sustainability Leaders Index, net of expenses.
The index is designed to provide exposure to the performance of a basket of large-cap companies that are global climate change leaders (as measured by their relative carbon efficiency) and are not materially engaged in activities deemed inconsistent with responsible investment considerations. The portfolio is hedged to Canadian dollars.
The fund was launched in October, 2018, and showed a one-year gain of 22.5 per cent to June 30. Impressive, but take a closer look. Almost 70 per cent of the fund is invested in U.S. stocks. Information technology makes up about 36 per cent of the portfolio. Health care adds 17.3 per cent and there is no energy exposure. So this fund is riding the tech wave, which is why its numbers look good. If high tech falters, so will this fund.
In short, the top-performing Canadian-based ESG funds are riding the high-tech boom to post superior results. I am still looking for a better-balanced entry, especially one that puts more emphasis on green energy.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.
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