As impact investing becomes mainstream in today’s investment, socially responsible ETFs are also growing. For instance, nearly thirty socially responsible ETFs are listed on the London stock exchange, all comprising asset value of around £ 4.8 billion.
The availability of various choices is good news to investors but requires greater attention when making those choices. Not all socially responsible ETFs are created the same way, and their complexity is growing.
Below are the key considerations to make to identify socially responsible ETFs accurately.
The Metrics the Fund Uses and Its ESG Focus
In this case, an investor should decide whether to focus on ETFs underlying social, governance, or environmental concerns. Also, it would be best to consider whether the metrics used in evaluating the ETF align with what you want to emphasize or align with the ESG criteria.
For instance, when investing in socially responsible ETFs that focus on the environment, you may consider their green revenues, fossil fuel reserves, and carbon emissions intensity. The companies reflect different attributes when various metrics are applied; therefore, the choice of a metric greatly determines your investment composition.
Sustainability of The Fund
It has not always been easy for investors to assess socially responsible ETFs and determine if they are genuinely sustainable and how they compare with other choices available in the market. To determine whether the fund is sustainable, you have to assess the fund based on how the company lives up according to some defined ESG criteria. However, many organizations have stepped forward in implementing sustainability ratings for various funds.
The Sector or Geographical Biases of the Fund
It is also essential for ethical investors to note that ESG scores vary across different sectors and geographical locations. Sometimes some geographical locations may be well inclined and leading in terms of sustainability; however, the emerging markets lead to a poor ESG score. Due to the nature of the underlying businesses, sectors like technology may have a higher ESG score, while oil and gas are prone to low ESG scores.
The Funds Tracking Error to The Broader Market
There is a potential tradeoff between higher ESG scores, low tracking error, and broad diversification. Therefore, optimization techniques can be used to reduce the tracking error because it is more likely for an investor wishing to replace a core portfolio with socially responsible ETFs to compromise the purity of ESG holdings to lower the tracking error and retain the diversification.
The Fund’s Track Record
Most socially responsible ETFs track indices with concise track records, which makes it challenging to analyze the fund’s performance over a long time to make a more informed decision. Therefore, the return-based analysis should rely on the backtest, which can be manipulated to arrive at the desired outcome.
Summary
To accurately identify socially responsible ETFs consider the metrics the funds use and their ESG focus. It is also essential to consider the fund’s sustainability and the sector or geographical location in which the fund is biased. Also, pay closer attention to the fund’s track record and tracking errors to the broader market.
