By Komson Silapachai, Research & Portfolio Strategy
In the two years since the onset of the pandemic, ESG ETFs have seen tremendous growth in both adoption and the breadth of options available to investors. As the space continues to evolve rapidly, we believe it’s important to identify major developments within the space, review performance, and explore what the next chapter of ESG ETFs could look like.
A Record Year for ESG ETFs
In a year that saw the strongest net flows into equity and fixed income funds in decades, ESG enjoyed record growth as well. For the year ending December 31, 2021, the universe of ESG-related ETFs that Sage tracks grew to $120 billion in total assets, up from $70 billion at the start the year – a 71% increase!
The top 25 ETFs in our universe accounted for $42 billion of the growth, and unlike the early years of ESG adoption, U.S. equities and the top 3 ETF sponsors weren’t the only beneficiaries of this growth. The big continued to get bigger; ESGU (iShares ESG Aware MSCI USA), ESGD (iShares ESG Aware MSCI EAFE), and ESGV (Vanguard ESG U.S. Stock ETF) garnered a whopping $12 billion, $3.6 billion, and $3.4 billion, respectively. The demand for ESG-integrated broad exposure ETFs remains, but the rise of narrower ESG strategies also bears watching and will continue to play a significant role in the growth of the ecosystem.
Carbon-focused funds were a huge draw for ESG investors in 2021, as LCTU (Blackrock U.S. Carbon Transition Readiness) and KRBN (KraneShares Global Carbon Strategy) grew by over $1 billion, with several other fossil fuel-free or carbon-transitioned focus funds appearing among the top 25. Water was a growing theme, with FIW (First Trust Water) and PHO (Invesco Water Resources) adding over $800 million in AUM.
In terms of fixed income, ESG ETFs in this segment had historically been nascent; however, the category displayed an encouraging growth trend. Blackrock led the way with EAGG (iShares ESG Aware U.S. Aggregate Bond) and SUSB (iShares ESG Aware 1-5Y USD Corporate Bond) in the top 25; however, VictoryShares, Nuveen, Vanguard, Janus Henderson, and VanEck also saw modest growth in their ETF lineups.
The Fastest Growing ESG ETFs in 2021
Source: Sage Advisory, Bloomberg
|Growth Rank||Name||Ticker||Growth ($Millions)||2021 Return|
|1||iShares ESG Aware MSCI USA ETF||ESGU||12,271||27%|
|2||iShares Trust iShares ESG Aware MSCI EAFE ETF||ESGD||3,636||12%|
|3||Vanguard ESG U.S. Stock ETF||ESGV||3,418||27%|
|4||iShares MSCI USA ESG Select ETF||SUSA||2,528||30%|
|5||Blackrock U.S. Carbon Transition Readiness ETF||LCTU||1,638||18%|
|6||KraneShares Global Carbon Strategy ETF||KRBN||1,605||108%|
|7||Vanguard ESG International Stock ETF||VSGX||1,591||7%|
|8||iShares Trust - iShares MSCI KLD 400 Social ETF||DSI||1,574||31%|
|9||iShares ESG MSCI USA Leaders ETF||SUSL||1,420||32%|
|10||Xtrackers MSCI USA ESG Leaders Equity ETF||USSG||1,292||32%|
|11||Global X Autonomous & Electric Vehicles ETF||DRIV||1,177||28%|
|12||iShares ESG Aware U.S. Aggregate Bond ETF||EAGG||1,028||-1%|
|13||First Trust Water ETF||FIW||917||32%|
|14||iShares Global Clean Energy ETF||ICLN||906||-24%|
|15||iShares ESG Aware MSCI USA Small-Cap ETF||ESML||883||19%|
|16||First Trust NASDAQ Clean Edge Green Energy Index Fund||QCLN||824||-3%|
|17||Invesco Water Resources ETF||PHO||821||31%|
|18||iShares MSCI ACWI Low Carbon Target ETF||CRBN||719||19%|
|19||First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund||GRID||685||28%|
|20||Nuveen ESG Large-Cap Value ETF||NULV||595||23%|
|21||Blackrock World EX U.S. Carbon Transition Readiness ETF||LCTD||583||4%|
|22||Nuveen ESG Small-Cap ETF||NUSC||577||18%|
|23||iShares ESG Aware 1-5 Year USD Corporate Bond ETF||SUSB||547||-1%|
|24||Nuveen ESG Large-Cap Growth ETF||NULG||522||28%|
|25||SPDR S&P 500 Fossil Fuel Reserves Free ETF||SPYX||513||28%|
ESG ETFs Performance in 2021
Last year was a historically strong year for equity markets that saw global equities returning 18.5%, led regionally by the U.S. with the S&P 500 posting a 28.7% annual total return.
In general, the broader-exposure ESG ETFs performed well; while their under-allocation to the energy sector (which returned 46.4% in 2021) certainly detracted from relative performance, their exposure to the larger, higher-profitability sectors (think mega-cap tech), served those strategies well during waves of Covid, particularly during the summer months when the Delta variant dampened reopening activity and sentiment. On average, U.S.-focused ESG ETFs, such as ESGU (iShares ESG Aware MSCI USA), ESGV (Vanguard ESG U.S. Stock), and USSG (Xtrackers MSCI USA ESG Leaders), tracked alongside or slightly outperformed the broad U.S. large-cap equity index, while small/mid-cap equities, as well as international equities, generated a lower return.
Narrow-focused ESG ETFs in the top 25 – with typically an environmental or low carbon focus – turned in lower returns given their lower energy exposure – and in the case of ICLN (iShares Global Clean Energy), had an outright negative year after a stellar 2020. Clean energy has a beta to aggressive growth and tightening financial conditions didn’t help it.
The Next Chapter
ESG has achieved mainstream adoption over the past few years, which has resulted in the broadest, most widely adopted market segments, such as U.S. large-cap equities, reaching critical mass. As the ecosystem moves into the next stage, we believe demand will increase for more specific market segments. ESG ETFs should see a higher number of sector/theme-specific strategies, as well as more granularity in international segments to different factor and country exposures.
This year, the number one concern for investors – by a wide margin – has been the outlook for inflation. “Will prices run so hot that it will damage the economy?” Supply constraints have ruled the day in keeping inflation elevated, particularly through higher commodity input costs. Add in geopolitical concerns around Russia/Ukraine, and the energy complex could remain supported. In general, ESG equities have lower exposure to the traditional energy and resources sectors, which have been the primarily beneficiary of this trend. Actively managing around this near-term headwind will be vital to outperforming the broader equity market for ESG-focused strategies.
Fed Policy Pivot
In recent years, nearly all markets have benefitted from an unprecedented period of easy money policy, which has fueled high valuations, as well as lifted prospects for growth for longer-term projects having to do with clean energy, electric vehicles, artificial intelligence, and other innovations. If valuations revert to a pre-Covid level, the question is, how will ESG-oriented assets perform?
Markets are entering into an epoch unlike anything we’ve seen in decades: from deflation to inflation, as well as from historic stimulus to rapid withdrawal. While ESG ETF performance could be in for a period of volatility over the coming year given concerns around Fed policy, geopolitics, and inflation, we believe the adoption of ESG, and in particular ETFs, will continue to grow due to secular trends beyond the current business cycle.
Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
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