One of the benefits of the environmental, social, and governance (ESG) investing movement is that it spurred a raft of research and studies comparing the performances of companies with strong ESG records and those that are “ESG offenders.”
Not surprisingly, publicly traded ESG offenders can expose investors to undue risk while public firms with strong credentials offer the potential for durable long-term upside. The other thing that’s not surprising is that stock picking to this effect is difficult, highlighting the advantages of ESG exchange traded funds such as the Invesco ESG Nasdaq 100 ETF (QQMG ) and the Invesco ESG NASDAQ Next Gen 100 ETF (QQJG ).
While no ESG mousetrap is 100% foolproof, the methodology employed by QQMG’s and QQJG’s underlying indexes lengthens the odds the ETFs will be home to multiple ESG offenders. That’s a positive trait for investors.
“In the first year of ESG controversies being made public, companies with environmental controversies or accidents suffered the most. Companies with governance controversies also tend to underperform within the first year, according to the report. Accounting scandals are also damning, with the median stock underperforming by 55% versus the market,” reported Lauren Foster for Barron’s, citing a Bernstein study.
At the sector level, some of the biggest ESG offenders have been energy companies. Think oil spills and related incidents. To that end, neither QQJG nor QQMG feature exposure to the energy sector. The former has a modest allocation to the materials sector and the latter has a small weight to utilities stocks.
The Bernstein research also indicates that “ESG improvers” can be a source of positive returns for investors. One way of looking at that is for investors to spend some time examining additions to the QQJG and QQMG portfolios when the ETFs rebalance in March, June, September, and December. Some of those additions could be previous ESG offenders that are now improvers. As such, those stocks could eventually be important performance drivers for these funds.
“Identifying new ‘ESG improvers’ isn’t always easy, however, and the process varies across investment professionals. One approach is to find companies that have sustainability challenges but also have credible plans in place to address the issues, such as an energy company that is investing in low-carbon technologies,” according to Barron’s.
While there are no guarantees QQJG and QQMG will be chock full of ESG improvers, the ETFs remain useful, cost-efficient avenues for avoiding companies that could be vulnerable to ESG controversies.
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