Many investors aren’t ready to concede returns just to avoid so-called “morally bankrupt” stocks, but with ESGU, you won’t have to, as it tracks the MSCI USA Index almost perfectly.
MSCI’s optimization constraints ensure this, and the majority of excluded stocks have negligible weightings in the S&P 500.
ESGU’s popularity is a reflection of this; it has assets under management of $22 billion with annual fees of just 0.15% and is an appropriate substitute for S&P 500 funds.
Ivan Martynov/iStock via Getty Images Investment Thesis
Like dividend investing, value investing, and growth investing, ESG investing can be done on a spectrum. You can invest in stringent ESG funds or try out some “ESG-lite” funds that put a bit of emphasis on environmental, social, and governance factors, but not enough to significantly change the risk and return profile of a target Index. The iShares ESG Aware MSCI USA ETF ( ESGU ) is very much in the latter category, which is likely why it’s so popular and has managed to slightly outperform the MSCI USA Index in the last 15 years.
For me, this is welcome news, as I’m skeptical that ESG factors – mainly environmental ones – are advantageous from an investment perspective. As frustrating as that stance is for ESG proponents, I’m still going to give ESGU a good review due to its methods for controlling risk and return relative to its parent Index. This article’s primary purpose is to put investors’ minds at ease about ESG, as socially responsible investing doesn’t always have to mean accepting inferior returns. ESGU Overview
iShares lists the fund’s investment objective on its website as follows: The iShares ESG Aware MSCI USA ETF seeks to track the investment results of an index composed of U.S. companies that have positive environmental, social and governance characteristics as identified by the index provider while exhibiting risk and return characteristics similar to those of the parent index. In addition, the fund has the following characteristics: Index: MSCI USA Extended ESG Focus Index
Expense Ratio: 0.15%
Dividend Yield (TTM): 1.14%
Assets Under Management: $21.95 Billion
MSCI ESG Fund Rating (AAA-CCC): A
MSCI ESG Quality Score – Peer Percentile: 75.39%
MSCI ESG Quality Score (0-10): 6.7
Equity Holdings: 327
Largest Sector: Technology (29.33%)
Concentration In Top 10: 27.74%
Methodology The fund’s one-pager gives an overview of its selection process: Source: iShares ESGU One-Pager To simplify things, it starts with the MSCI USA Index, which has over 600 constituents and eliminates about half of those companies through a combination of exclusions (controversial weapons, civilian firearms, tobacco, thermal coal, oil sands) and an Index optimization method. A near-perfect risk and return profile (relative to the MSCI USA Index) is achieved by applying certain optimization constraints.
I’ve listed the most important ones below, taken from the MSCI Extended ESG Focus Indexes Methodology document. Active Sector Weights: +/- 5% Active Constituent Weights: +/- 2% Minimum Constituent Weight: 0.1% Predicted Tracking Error: 0.5% The purpose of the relatively low active sector and constituent weight constraints is to ensure that the Index’s risk and return profile isn’t too different than the MSCI USA Index. The 0.1% minimum constituent weight constraint functions to eliminate the vast majority of holdings. To put this into context, 289 constituents in the S&P 500 have weightings of less than 0.1%, and while the MSCI USA Index is about 25% larger to include some mid-caps, the effect will still be significant.All of this culminates in a predicted tracking error of just 0.5%.
This means that in each year, you can expect ESGU’s performance to be almost identical to the MSCI USA Index, which, in turn, is nearly identical to the S&P 500. I’ll go over this tracking error in more detail later. Sector Exposures and Top Holdings Below are ESGU’s sector exposures, showing that most are in Technology, Health Care, and Consumer Discretionary stocks.
Together, these three sectors total 53.97% of the fund vs. 53.04% for the iShares Core S&P 500 ETF ( IVV ).ESGU’s top ten holdings account for 26.26% of the fund, as shown below, compared to 27.98% for IVV. Fundamentals Snapshot Finally, to further support the argument that ESGU is an acceptable substitute for the S&P 500, here is a snapshot of the fund’s top 20 holdings, with net metrics for the entire fund against SPY’s shown in the final row. Source: Created By Author Using Data From Seeking Alpha You can see that the concentration among the top 20 holdings is near identical (36.16% vs. […]
source ESGU: Dip Your Toes Into ESG Investing Without Sacrificing Results