More and more investors are making ethical practices a high priority for stock picking. People want their investments to deliver great returns, but they also want to support companies that act responsibly, sustainably, and fairly. In a world that's increasingly socially conscious and interconnected, investors are more likely to find value in stocks and funds that specifically address environmental, social, and governance (ESG) issues, as they are called. This focus is gaining popularity in boardrooms and among fund managers, and we should expect it to be a trend in the stock market for the next few years.
If ethical investing is interesting to you, consider adding these three ETFs to your portfolio.
iShares ESG Aware MSCI USA ETF
The iShares ESG Aware MSCI USA ETF (ESGU +0.18%) tracks an index of ESG-focused companies in the United States. The index is composed of stocks that score well on factors such as carbon emissions, waste, labor relations, ethical sourcing, safety, corruption, and anti-competitive practices. The fund also excludes tobacco producers, certain weapons makers, and other controversial companies.
The fund is weighted passively in a manner meant to mimic market performance, while focusing on the roughly 350 companies with sufficient ESG scores. The resulting portfolio is weighted heavily toward tech stocks, which represent about 35% of the total holdings.
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Investors will be pleased to find that this niche ETF maintains a reasonable 0.15% expense ratio and good liquidity. Average daily trading volume is over $50 million, which isn't necessarily the highest, but still sufficient for most investors to avoid any problems with illiquidity. Specifically, a 0.04% bid-ask spread is low enough that it won't drive up trading costs and chew into returns.
iShares ESG Aware MSCI EM ETF
The iShares ESG Aware MSCI EM ETF (ESGE 0.14%) is very similar to the aforementioned U.S. version, but it only holds stocks from emerging markets. The screening methodology applied to a larger universe of international stocks results in roughly the same number of holdings, but with slightly different concentrations. Tech is again heavily represented with over 40% of the portfolio, but financials also make up a hefty 22%. The fund's holdings are also heavily concentrated in Taiwan, Hong Kong, South Korea, China, and India, which together make up about 75% of the total allocation.
iShares' emerging markets ESG fund carries a slightly higher 0.25% expense ratio, but this isn't cost-prohibitive for investors who like the approach. Despite being a smaller fund than its U.S.-focused cousin, the emerging markets ETF has similar daily trading volume and a tight bid-ask spread, providing ample liquidity for most investors. It should be easy and inexpensive to acquire or unload in a timely fashion.
Vanguard US ESG Stock ETF
The Vanguard ESG U.S. Stock ETF (ESGV 0.04%) is Vanguard's largest offering to compete with the above, with nearly $3 billion assets under management. This fund tracks a different index, the FTSE US All Cap Choice Index, which results in a slightly different composition. The portfolio excludes industries such as alcohol, tobacco, and weapons, but it goes further to omit fossil fuels, nuclear energy, gambling, and adult entertainment. The methodology also screens companies using U.N. standards for labor rights, environmental stewardship, and corruption.
By targeting all market capitalizations, the fund winds up holding nearly 1,500 different stocks. Despite this extra diversification, it's still market-cap-weighted, meaning that it is still dominated by the same handful of the largest companies as the iShares U.S. fund above. Its sector exposure is also very similar.
Vanguard delivers this investment option at a very reasonable 0.12% expense ratio, so return erosion should be minimal. Investors should recognize the meaningfully smaller daily trading volume of only $22 million, with a slightly higher 0.06% bid-ask spread. These are by no means prohibitive and should provide ample liquidity and tradeability for most holders, but it's worthy of consideration.
Is ESG right for you?
Some critics may contend that ESG funds are a product of a long-term bull market causing investors to take returns for granted. If ESG does turn out to be a fad, then the above ETFs might lose popularity and experience lower trading volume.
However, record inflows to sustainable funds in the first quarter of 2020 might suggest otherwise. On the back of a tumultuous and stressful year, ethics are more important now for many investors. It's up to you whether or not to consider ESG ratings when allocating your money, but this is a great place to start for interested investors.
