ESG ETFs are gaining traction

“Before 2017, there was only one ESG ETF in Canada, the iShares Jantzi Social Index ETF (XEN),” says Daniel Straus, vice-president, ETF research, at National Bank of Canada Financial Markets. “Since 2017, and up to November 2018, 13 new funds saw the light of day. The iShares ETF dates back to 2007 and in its 10 years of existence, it accumulated assets of only $50 million. But in 2018 alone, it witnessed an inflow of another $50 million.”

The most promising development hinges on RBC’s Vision Women’s Leadership MSCI Canada ETF (RLDR). Launched in March 2018, it raked in $195 million in nine months, which leads us to believe that “it may have come with a certain institutional lead order,” comments Strauss.

At the end of November 2018, ESG ETF assets totalled $410 M. “The industry has now reached a critical mass,” claims Straus, “and we should now witness a lot of innovation and proliferation in this space.”

To date, the Desjardins line up stands out as the most innovative and complete in the Canadian industry. Mary Hagerman, a portfolio manager and financial advisor at Desjardins Wealth Management who pioneered the use of ETFs at her firm, neatly sums it up: “Together, all these ETFs allow me to create a complete portfolio that is globally diversified and has an ESG orientation.”

Though the eight ETFs adhere to the three fundamental ESG criteria of environment, society and governance, they show a very strong environmental leaning that seeks to address climate change risks. Seven of the funds target companies that have a low carbon footprint, whilst the eighth one shies away from any exposure to fossil fuels (oil, gas, coal). Apart from the ESG theme, the eight funds canvas all markets: Canada, U.S., developed markets and emerging markets. A bond ETF – unique in the Canadian ETF landscape – is restricted to Canada.

Two of the eight ETFs have still not been launched, but should do so shortly, says Jay Aizanman, Director of Business development DGAM. The delay involves a global stock fund, the other, an emerging market one. “Both are held up by authorities in India where processes are typically slow, says Aizanman. We hope to get the okay any week now.”

Another distinctive trait is the multifactor approach that four ETFs adopt. Designed with the help of French firm Scientific Beta, the factors put forward are value, momentum, size, low volatility, earnings, and small investment (companies that invest less show a tendency to outperform). “These factors are those for which historical outperformance has been the most documented,” explains Guy Lamontagne, vice-president, investment strategies, at DGAM.

Assembling the ETFs happens by applying algorithmic filters in five steps, Lamontagne says. First, companies excluded from the United Nations’ global registers are eliminated. These include weapons manufacturers and companies that utilize child labour. Next, only companies with the highest ESG ratings are retained; companies are eliminated if, while subscribing to ESG principles, they still deviate significantly from one of its themes. A fourth filter isolates companies whose carbon intensity is 25% lower than those contained in the large stock market indices. Finally, in the case of four ETFs, the six-factor filter is applied and, in the case of two others, a filter that weighs stocks according to their market capitalisation.

Desjardins’ ETFs are unique, recognizes Dan Hallett, principal at Highview Financial, in Toronto, but they seem opportunistic, exhibiting “an attempt to exploit a flavour of the day”, he says. They try to straddle two trends: climate anxiety and multifactor investment. Sure, Desjardins’ approach calls on strategies like small caps and momentum that historically have beaten indices. “And they could very well continue to outperform, but beware, if too much money goes after a factor, its advantage could disappear and some factors could be ill suited to work in combination,” he says.

ESG investment could also come to suffer from overextension, Hallett thinks, who sees ESG criteria being increasingly applied by a growing number of portfolio managers who don’t claim any specific ESG mission. In his view, the way of the future lies in “impact” investment which targets companies or projects that aim at contributing directly to social or sustainable environmental changes.

None of Desjardins’ eights ETFs moves in this direction, but it is an orientation not to be written off when one considers Desjardins’ launch of its Socie Terra Positive Change mutual fund that came out at the same time as the ETFs. This fund is meant to satisfy the wish of investors who want their money to participate in “changing the world”. Investors will be able, for example, to invest in a company that produces enzymes and probiotics meant to replace pesticides in agriculture, or invest in a bank that performs micro-loans to financially disadvantaged populations.