When I took stock of the universe of sustainable exchange-traded products at this time last year–just ahead of the Morningstar ETF Conference–I noted the rapid increase in the number of diversified equity offerings pursuing sustainable investing, meaning they incorporate environmental, social, and corporate governance considerations in their investment processes. A year ago, 20 such funds existed, 17 of them having been launched in 2015 or in the first eight months of 2016. Together, they totaled $1.9 billion in assets.
A second issue is asset size. While their ranks have been growing and AUM is up about 65% from this time last year, most sustainable ETFs are small and remain well below the size necessary to be viable over the long run. Only eight funds currently have assets greater than $50 million. This is a concern, because persistently low AUM puts an ETF at risk of closure. Because the growth of investor interest in ESG still seems to be in the early stages, I would expect that most recently launched ETFs will be given time to establish viable performance records and to attract assets on that basis. It’s worth considering who the issuer is, as those with greater ETF and sustainable investing experience and deeper pockets may have more patience in letting their funds get to scale.
Finally, there are fees. For years, iShares has charged 0.50% for the two oldest and largest diversified ESG ETFs: iShares MSCI KLD 400 Social ETF and iShares MSCI USA ESG Select ETF . In a world where low fees reign, and where an S&P 500 ETF costs a scant 0.04%, it’s increasingly hard to sell yourself or a client on a U.S. large-cap ESG ETF that costs 12.5 times more. That difference, 46 basis points in this case, is more than enough to offset DSI’s performance deficit versus an S&P 500 ETF. During the trailing 10 years through June 30, iShares Core S&P 500 ETF gained an annualized 7.13%, which was just 26 basis points better than that of DSI’s 6.87% annualized gain. Fees are coming down. Several of the new U.S. large-cap offerings are charging 0.35%, and fossil-free and low-carbon offerings, which don’t consider broader ESG issues, charge 0.20%. Just this month, BlackRock slashed the fees on three of their sustainable investing ETFs: iShares MSCI USA ESG Optimized ETF now costs 0.15%, down from 0.28%; iShares MSCI ESG Optimized ETF now costs 0.20%, down from 0.40%; and iShares MSCI EM Optimized ETF now costs 0.25%, down from 0.45%.
The universe of sustainable diversified ETFs is relatively new, small, and expensive when compared with conventional diversified equity ETFs. You can adjust for short performance records by examining the longer records of the indexes upon which a fund is based. If you are considering a small fund, take a look at the issuer and how well it is established in the ETF and sustainable investing spaces. Investing with better-situated issuers increases the odds that the fund will grow to scale and remain open. Focus on ETFs with expenses of 0.35% or less. They are more likely to perform better and grow assets. You can still play it safe by paying 0.50% for DSI or SUSA, purchasing the comfort of their size and established performance records, but their records might also be considered proxies for the smaller, newer, and cheaper sustainable ETFs now available. If DSI and SUSA were able to provide competitive performance over the long run at 0.50%, newer funds based on similar kinds of indexes and charging investors less could do just as well.
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