You Can't Charge For Doing Good

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You Can't Charge For Doing Good

US listed exchange traded funds dedicated to environmental, social and governance concerns are still quite small but are growing at a steady clip in 2019. A few data points:

  • The current aggregate market cap for ESG ETFs stands at $11.2 billion, just 0.3% of total assets under management for US listed ETFs.
  • Inflows this year, however, total $1.8 billion – 16.1% of current assets.
  • That compares to total ETF inflows in 2019 of $72.6 billion, or just 1.8% of total assets under management ($3.9 trillion).
  • All data courtesy of www.xtf.com

The bottom line here is that ESG ETFs are taking share from traditional exchange-traded investment products, but this is a very recent trend:

  • That $1.8 billion of YTD inflows for ESG funds is 90% of all the fresh money they have pulled in over the last 12 months.
  • Compare that to total ETF flows, where only 25% of total 12-month inflows ($288 billion) has come in 2019.

A recent Wall Street Journal article outlined one reason ESG funds are gaining share: lower fees. As ETF sponsors compete in this still-niche sector, they are cutting expense ratios. The flow data shows this is working:

  • The average expense ratio for an equity ESG ETF is 43 basis points. This already compares favorably to the 50 basis point average expense ratio for ETFs that run any “enhanced strategy” portfolio.
  • The ESG ETFs with the largest YTD inflows all charge substantially less than that average.
  • The top ESG ETF asset gatherer YTD is a Deutsche Bank US equity product (USSG) that only charges 10 basis points. It has pulled in $846 million YTD, half of all ESG inflows.
  • Vanguard’s US equity ESG product (ESGV) is in second place YTD in terms of flows, at $245 million. The expense ratio here is 12 basis points.
  • As a reference point, consider that SPY charges 9 basis points and IVV (the iShares S&P 500 product) has only a 4 basis point expense ratio.

So… ESG equity funds have caught the fee-cutting bug endemic to the rest of the money management industry, but how’s the performance? Here are the 4 largest general-purpose ESG ETFs with at least a 1-year track record to consider that question:

#1: iShares MSCI KLD 400 Social ETF (DSI):

  • YTD price return: +16.9%
  • One-year price return: +9.7%
  • DSI is primarily a large cap product (84% of the portfolio), so the S&P 500 is a good comp: +16.0% YTD, +8.6% over the last year
  • Verdict: DSI has beaten the S&P over the YTD and the last year

#2: iShares MSCI USA ESG Select (SUSA):

  • YTD price return: +17.9%
  • One-year price return: 8.0%
  • SUSA is also a large cap product (78% of the portfolio), so the same S&P 500 returns noted above apply
  • Verdict: SUSA is better than the S&P over the YTD but not the last year.

#3: iShares ESG MSCI EAFE (ESGD):

  • YTD price return: 13.1%
  • One-year price return: -5.2%
  • Comparable MSCI EAFE returns: +13.2% YTD, -6.2% over the last year
  • Verdict: ESGD’s performance is a wash over the YTD, but better over the last year than its notional benchmark.

#4: iShares ESG MSCI EM (ESGE):

  • YTD price return: +14.9%
  • One-year price return: -5.3%
  • Comparable MSCI Emerging Markets return: 13.8% YTD, -6.7% over the last year.
  • Verdict: ESGE has outperformed its notional benchmark over the last 12 months and YTD

What all this says to us:

If there is one differentiated good in equity investing that should merit a distinct premium to commodity offerings, it is ESG. The stereotypical buyer of an ETF in the space is supposed to be either idealistic (i.e. younger investors) or pushed to invest because of an institutional mandate (i.e. smaller pension funds, endowments and the like). Neither seems like a fee-sensitive consumer, but they clearly are.

The premium for an ESG portfolio is clearly shrinking, and that speaks volumes about the state of the US asset management business. First, scale is critical since fee structures are still in decline. Second, that scale is still expensive to build since it requires sales, access to recognizable index creators, and time to ramp. Finally, in a world where 3 companies (Blackrock, State Street and Vanguard) already control the largest slices of the pie, the possibility of successful new entrants seems remote.

Bottom line: buying ESG ETFs is OK, but investing in asset managers is clearly a different story all together. Because if you can’t charge for “doing good”, what in the world can you charge for?