Exchange-traded funds (ETFs) that invest in securities with sustainability goals are growing in popularity. According to predictions from BlackRock, the world’s largest asset management firm, sustainable ETF fund assets are poised to grow from the current $25 billion to more than $400 billion by 2028. Millennials, in particular, are attracted to these ETFs because they offer low fees and broad diversification while catering to social impact goals.
Sustainable or impact investing are normally the realm of high net worth individuals. But the rise of sustainable ETFs is “a fantastic way to move the whole space of sustainability from the margins to the mainstream,” said Durreen Shahnaz, founder and CEO of the Impact Investment Exchange (IIX) in Singapore, a social stock exchange and impact investing private placement platform. An ETF — a basket of securities that is traded like stocks — is more accessible to small investors because it has a low threshold to entry.
ETFs could be used to pursue ESG (environmental, social and corporate governance) goals like gender equality and bring about greater representation for women in various areas, such as on corporate boards, Shahnaz said. The growing interest in sustainable ETFs has given rise to some other esoteric versions, such as vegan ETFs or those focused on LGBT rights. “People are asking if we could hold publicly listed companies accountable [through] this lens,” she added.
Companies do need to be held accountable on their commitment to environmental, social and governance (ESG) principles, said Aniket Shah, head of sustainable investing at OppenheimerFunds, which has more than $213 billion in assets under management. “Investors need to demand that the fund managers who manage money on behalf of them are advocating for these types of changes with the money that they are investing on behalf of individual investors.”
Shah and Shahnaz discussed how sustainable ETFs can advance the goals of impact investing in a recent podcast for the second season of the Knowledge at Wharton series, From Backstreet to Wall Street. This series focuses on women, innovators and entrepreneurs who are building sustainable peace. (Listen to the podcast above; you can find the rest of the series here.)
How Index Investing, ESG Can Co-exist
While the rise of index investing has its benefits — lowering costs for investors, making investments more transparent and diversified — it has shortcomings as well. “The challenge that comes with index investing is that you are in a way a passive investor,” Shah said. The low fees collected by asset managers act as a disincentive for them to engage in shareholder activism, and “it ensures that the status quo continues,” he added. Further, managers of funds that invest in a large number of companies will find it challenging to develop relationships with them, Shah said.
“Most people just don’t have a clue … how their own money is invested and what impact it’s therefore having — good and bad — on the world.” –Aniket Shah
However, there are ways to get around those challenges. One way is for index fund managers to try to incorporate some the ESG data into the construction of their indices. “[They] could tilt portfolios to either companies that are improving their ESG profile or those that are maybe not doing very well now but could improve in the future,” Shah said.
“The second way that ESG investing and index investing can coexist is through active ownership and to ensure that you are voting your proxies in a way that is aligned with pro-social and pro-environmental goals,” Shah added. He pointed out that OppenheimerFunds has “one of the most pro-climate change, pro-environmental voting records from our proxy policy on Wall Street, where we vote in favor of over 60% of all climate change resolutions and climate change-related resolutions — a number that is matched by very few other large asset managers.”
Shah acknowledged that “ESG data is imperfect, incomplete and qualitative.” To optimize its view, OppenheimerFunds has various ESG products that use data from MSCI, a provider of global stock market indices, and Sustainalytics, which rates companies on their ESG performance. These tools “allow end-investors to have market exposure, but with a tilt towards companies that have strong ESG profiles,” he added.
Empowering Women, Feedback Loops
Empowering women through impact investing is a prime calling for Shahnaz. She led IIX to issue its first Women’s Livelihood Bonds in 2017, which raised $8 million to help 385,000 women entrepreneurs in Southeast Asia. IIX is currently seeking to raise $100 million in the second edition of those bonds.
IIX has been engaging with the beneficiaries of those bonds in a “feedback loop” to study the impact on their lives. “If we can take it to the next stage of getting feedback from the people who are using [a company’s] product or the service of one of the stakeholders, it will make it that much more powerful and will bring us closer [to the goals],” Shahnaz said.
Shah said the feedback loop improves investors’ understanding of the ESG impact of individual companies. “How are the end users of the products and services of these businesses actually engaging with their products, feeling about them, and so on?” is an example of how such feedback could bring clarity, he said.
“One’s imagination could go quite wild about whether you can take those types of insights in the construction of new ways of investing,” said Shah. “[The combination of] ESG and index investing could be incredibly powerful if we guide it and direct it in the right way.” Active engagement with company management along with a strong understanding of ESG performance are important, he noted.
By marrying ESG goals with investing, individual investors get opportunities to engage in “at least some form of advocacy with your dollar,” said Shahnaz. “This is another mechanism that has the potential to allow companies to start thinking about changing their practices.”
The relationship between the financial markets and ESG goals swings between extremes, Shah noted. “We bounce back and forth between incredible optimism and unbelievable cynicism and pessimism, and both of them are well founded,” he said. “Technically speaking, change is possible, [but] we are fighting against enormous amounts of inertia and enormous amounts of apathy,” he added.
“If we can have more women-related products and women-focused services, and link all that to financial performance, we’ll see a different world.” –Durreen Shahnaz
Here, insufficient financial literacy among investors is one of the many shortcomings of the U.S. financial system, Shah noted. “Most people just don’t have a clue as to how the financial system works, and down to an individual level, how their own money is invested and what impact it’s therefore having — good and bad — on the world.”
According to Shah, the need to improve financial literacy is all the more important because investors are exposed to “industrial scale greenwashing,” where companies make false or unsubstantiated claims about the environmental benefits of their products or services. “We have to keep fighting, and particularly fight the ignorance.”
Going forward, Shahnaz wanted to see greater representation for women in the capital markets. “If we can have more women-related products and women-focused services, and link all of that to financial performance, we’ll see a different world,” she said. “You have more impact on not just the woman herself, but the family and the community. It has been shown over and over again that when you have … women in the equation, all of a sudden the risk in an investment goes down. Women are more reliable.” She said that is evident even with a simple product like car insurance, where premiums are lower for women.
In order to achieve those goals, Shahnaz said it would help to have “more financial products that are easy for investors to come in, and are focused on women’s services or on impacting women.”
Shah said the global sustainable development agenda needs “more and better government-sponsored programs.” He also wanted corporations and high net worth individuals to be held to account on their ESG footprint. Further, he called for everybody to do their bit. “If I could wave a magic wand, I would have every corporation and individual pay their fair share in taxes and not be hiding the extraordinary amounts of money that are currently being hidden and siphoned away in these tax havens that are growing by the day,” he said. “[They are] starving governments around the world from being able to finance and support many of the basic public goods that they should be providing.”
“Corporate accountability and corporate transparency will happen ultimately if the individuals who invest in these companies and invest in the securities of governments through their bond issuances demand it,” said Shah. That would take “some real courageous efforts from people within the industry to take a look at what they’re doing and change their behavior,” he added. “That will only happen if their shareholders and their constituencies are telling them, ‘We need you to change. Otherwise, we’re walking.’”