BMO's new suite of ESG ETFs

What they include, exclude, how they picked fixed income and why there are some Canadian names that didn't make the cut

Ruth Saldanha 10 February, 2020 | 1:55AM

 

 

Ruth Saldanha: At the end of last month, BMO Asset Management launched seven environment, social and governance or ESG ETFs, including a balanced ESG ETF called the BMO Balanced ESG ETF. The funds begin by eliminating entire sectors, including gambling, tobacco, nuclear power, weapons and alcohol, and include companies that have an ESG score in the top half of the companies within that sector. To discuss the new product BMO Global Asset Management's Head of Product, Mark Raes, is here with us today.

Mark, thank you so much for being here today.

Mark Raes: Thank you for having me.

Saldanha: To begin with, there are some sectors like weapons and alcohol that are always usually excluded from ESG funds. So, how do you decide what to exclude and what not?

Raes: I think it's an ongoing iterative process where we're in contact and communication with the index provider and just as importantly, with our clients and our potential clients to try to come up with maybe not convention but a consistent view on what should be in or out. So, I think we can all agree on certain things, whether that's weapons manufacturing, whether that's tobacco, whether that's alcohol, things like that, I think there's a pretty standard response when you consider them in terms of ESG inclusion. But that keeps changing. And I think there will be more to come on that front. And we should expect that over time as people's attitudes change alongside expectations in the market.

Saldanha: Two rather big sectors in Canada that are slightly on the murkier side of whether it's ESG positive or negative are oil and gas and cannabis. How do you play these two sectors for the funds?

Raes: I think that's been our number one conversation point out of the gates where some people would turn around and take a more legacy view and say it's about exclusion and not include energy and not include some of the cannabis stocks. I think today's ESG, which is far more about sustainability, is about include and improve as opposed to exclude. So, in other words, if we knocked out an entire sector like energy, it would be really hard to help drive positive change within these companies. So, instead, what we're looking to do is represent the market and ensure that we're working with companies to improve their approach to ESG, of course, environmental being quite important on the energy side. Whereas with cannabis stocks, I think that's very much an emerging space. But you need to keep in mind that a lot of the positioning around these companies is around medical usage. And so, as more comes out on that front, perhaps things will change. But right now, that's a key part of the healthcare sector and we do view it as an important part of the portfolio.

Saldanha: How active is the process and how often do you rebalance?

Raes: So, it's a quarterly rebalance. So, as you can imagine then, we're really looking through at these companies quite consistently with the index provider. What I think is important is, throughout the period, there is ongoing monitoring for controversies, things in the media, governance issues cropping up and that can cause a name to come right out for rebalance and not necessarily wait for a great period of time.

Saldanha: Now, you have a balanced fund. It's quite interesting because it mixes both equity and fixed income. Investors usually understand ESG screens for equity quite easily. But fixed income is slightly less easy to understand. Can you explain how you apply an ESG screen on fixed income?

Raes: Yeah, we've tried to come up with a reasonably consistent approach so that when someone invests in a balanced product or across the shelf, they understand what we're doing. So, we're doing the same thing where we're using the MSCI ESG ratings to exclude sort of some of the companies to capture the leaders. So, in the same way that you might think of as a bond credit rating, that ESG rating that is the basis of how we're including or excluding companies to make sure we're capturing essentially the top half of the marketplace. I think when people think ESG bonds, they're starting to think more and more about green bonds. That's still in its infancy. That market has a little bit to go in order to build a portfolio and having a diversified approach. So, what we're doing right now, I think, is the most effective way to approach the marketplace.

Saldanha: Finally, let's talk about equity. There are some major exclusions in the fund. You don't have names like Royal Bank (RY), you don't have names like Air Canada (AC). From the U.S. side, you don't have most of the FAANG stocks. Why is that? And how will these funds generate alpha without these big growth companies?

Raes: Yeah. Well, you need to recognize that we're capturing half the sector. So, that's deliberate in our approach that we're wanting to capture the ESG leaders. So, when we look at the banks in Canada, they fairly consistently score highly. And so, what's just occurring there is, there are certain banks that are outscoring others. It's not necessarily that another bank is a laggard. It's just that everyone is scoring reasonably well. In the case of the Royal, there are certain issues, such as being one of the named banks in the Libor scandal that sets it apart from some of the other banks. For Air Canada, that gets captured within the industrial sector, where an airline probably has a little bit of a harder time coming through. Whereas a company like CN Rail is in the portfolio with a stronger environmental approach. So, that's Canada.

As to the FAANG stocks, it has been fairly unique over the last couple of years where certain stocks have really dominated the contribution to return of the U.S. market. We do have some of them like Google, but we don't have others. So, Amazon is a company that really comes up a lot in terms of ESG, where the carbon footprint and some of the labour issues, again causes it to score a little bit lower to some of its competitors.

So, overall, I would turn that conversation on its head and say, there isn't a performance gap with ESG. So, if you want to align your investments with your values, it's not an impediment. So, there's no reason not to in terms of performance. And a short-term blip in the U.S. market, but if you look to the long term or if you look globally or if you look at Canada, the ESG approach does actually outperform.

Saldanha: Thank you so much for joining us today, Mark.

Raes: Thanks for having me.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Air Canada Class B15.99 CAD-2.26
BMO Balanced ESG ETF29.95 CAD0.50
Royal Bank of Canada94.83 CAD1.49

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Ruth Saldanha

Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca

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