ESG Fund Performance vs. Non-ESG

Reading Time: 9 minutes

Table of Contents

ESG investing considers Environmental, Social & Governance factors as part of the investment decision. Some ETFs choose their companies based on their own research, and some follow a social responsibility index like MSCI KLD 400 Social Index. The index weighs 400 US companies based on capitalization and excludes companies that have low ESG ratings. Obviously, the index doesn’t just take into account good ESG performance but also takes into account the following factors. Sounds interesting, but what’s ESG fund performance vs. non-ESG is like? Are ESG funds worth it?

MSCI ESG criteria

Top ESG ETFs

I will start by looking at some of the most popular ESG ETFs on the market today and compare their performance, composition, fees & risk profile. To keep it diverse, I will look at three general market ETFs and two energy-focused ETFs.

iShares MSCI USA ESG Select ETF

Vanguard ESG U.S Stock ETF

iShares ESG Aware MSCI EM ETF

iShares Global Clean Energy ETF

Invesco Solar ETF

Let’s jump straight into backtesting.

SUSA vs. SPY

SUSA’s objective:

The iShares MSCI USA ESG Select 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.”

Let’s compare a hypothetical $10,000 investment in iShares MSCI USA ESG Select ETF – SUSA and compare it S&P500 ETF – SPY.

SUSA vs SPY Performance

Interestingly, SUSA mirrors the performance of SPY almost perfectly. Here are the Top 10 Holdings of SUSA compared to Top 10 Holdings for SPY.

SPY

SPY Top 10 holdings

SUSA

SUSA Top 10 holdings

Aha, that is quite an overlap, especially in the technology sector. SUSA is capitalization-weighted ETF (How to understand ETF weighting methodologies?), so it is heavily weighted in the biggest stocks, which in today’s market, are technology stocks.

SUSA only has 200 holdings compared to 508 of SPY, but the exclusion of that many companies doesn’t impact the performance. That is the downside of top-heavy ETFs like that. A few key companies drive the majority of results. The Information Technology sector represents almost 30% of all holdings.

SUSA Industry Exposure

Fees

SUSA follows the MSCI ESG index and doing that is more expensive so it would make senes if SUSA will have a higher Management Expense Ratio (MER) and it does.

SUSA vs SPY Fees

Is SUSA a good buy today?

So what are we getting with this ETF? We get performance that is very close to that of S&P500 but is more ESG focused. You will also give up 0.16% of your return to fees compared to SPY. Just like SPY, SUSA is exposed to the technology sector quite a bit, so by investing in it today; you have to be bullish on the tech sector in general.

What are analysts saying about tech stocks?

At the time of writing this in August of 2021, analysts remain Very Bullish on top technology stocks and expect the sector to grow.

Top tech holdings analyst ratings

Read Related: Is tech overvalued? In 2021

ESGV vs. SPY

Vanguard’s ESG fund doesn’t have enough history to successfully backtest. We can only compare the last few years.

ESGV vs SPY Performance

Very short period to make any decisive conclusions, but the ETF mimics SPY very closely. Here is a look at monthly performance.

ESGV vs SPY Performance

How can that be? Well, it is the same story as with SUSA. Cap-weighted ETFs from U.S will all have very heavy technology stock weighting. Here is the Top 10 for ESGV.

ESGV Top 10 holdings

Ah, looks familiar. It is the same stocks all over again. The technology sector represents over 30% of ESGV, so keep that in mind if you decide to buy it.

ESGV vs SPY Fees

ESGV is quite cheap at 0.12% compared to SUSA 0.25%.

Notable difference is that Vanguard’s ESGV is a massive ETF with over 1200 holdings. It doesn’t follow the MSCI rigorous guidelines of what ESG means. Vanguard’s strategy here is to follow the FTSE US All Cap Index with companies being excluded from the list.

Specifically excludes stocks of certain companies in the following industries: adult entertainment, alcohol, tobacco, weapons, fossil fuels, gambling, and nuclear power.

Is ESGV a good buy today?

Compared to SUSA, ESGV is a lot more diversified with over 1200 holdings, but at the same time, it is 30% in technology stocks. When one sector is so heavily dominant in the ETF, we should ask ourselves what the future prospects of that sector are.

So far in 2021, technology stocks have been performing very well. Coronavirus made a lot of tech-related services more in demand, and the earnings reflected that very well; just look at the most popular stock’s Earnings per share growth over the last year.

Tech stocks earnings per share growth

Is this growth sustainable, and will it continue in the future? Hard to say, but top analysts across the internet & Wall Street all remain very bullish on the sector.

ESGE vs VWO

Ishared ESG Emerging Market ETF – ESGE compared to Vanguard’s Emerging Market ETF VWO.

ESGE vs VWO Performance

There isn’t much historical information, but it looks like the two funds track each other almost perfectly. It makes me wonder if there is much difference in holdings between ESG and non-ESG Emerging Market ETFs.

ESGE Top 25 Holdings

ESGE Top holdings

VWO Top 25 Holdings

VWO Top holdings

VWO is a massive ETF with over 4200 holdings compared to ESGE of only 344. Yet the there is significant overlap in top holdings for both ETFs, specifically Taiwan Semiconductors, Tencent & Alibaba, making up around 15% of the ETF.

Fees

ESGE vs VWO Fees

ESGE is slightly more expensive, but looking at the concentration of assets, slightly better historical performance, and similarity to VWO, but with the ESG aspect, ESGE might be worth it. Especially for somebody looking to expand into emerging markets but doing so with ESG in mind.

Clean Energy

How clean is “clean” energy remains a debate. Once scientists study an energy source in more depth, they uncover new ways that it has negative impact on ESG.

We will ignore that aspect for this analysis and purely focus on financial performance. The argument made boy the industry is that over the long-term, clean and sustainable energy will outperform, so perhaps, it doesn’t make sense to do historical backtesting here. However, as I often say, history is not meaningless and can at least provide us with somewhat realistic expectations for the future.

ICLN vs XLE

iShares Global Clean Energy ETF vs. Energy Select Sector SPDR Fund

Hypothetical $10,000 investment in both funds made in 2008, yield quite poor results for both funds. XLE has consistently outperformed ICLN throughout most of its history until a massive drop in 2019.

ICLN vs XLE 10k investment

At the same time that is exactly when clean energy starting to pick up speed. Looking at the chart, it looks like the two ETFs are perfectly negatively correlated.

Why is that?

Let’s take a look at XLE’s top 10 holdings.

XLE Top holdings

Okay, that makes it very clear. Buying XLE is buying top oil companies so it would make sense for the price of XLE to fluctuate in sync with oil prices.

Here is the Average Crude Oil Spot Price plotted against XLE.

Average crude oil spot price vs energy select sector SPDR ETF Price

XLE is an incredibly top-heavy ETF which is another downside. 50% of the ETF are 3 Oil companies. If I were to invest in oil, I would research those companies separately and consider investing but not through an ETF.

Past Performance Not Guarantee of Future Results

I believe that is definitely going to be the case with clean energy. ICLN has underperformed for a 10 year period compared to oil, until recently. Will that trend continue?

Oil is not going away any time soon but the growth of renewable energy sources is growing at incredible pace across the globe.

Renewable energy is the fastest-growing energy source in the United States, increasing 100 percent from 2000 to 2018.

Renewables made up 26.2 percent of global electricity generation in 2018. That’s expected to rise to 45 percent by 2040. Most of the increase will likely come from solar, wind, and hydropower.

Source: Renewable Energy | Center for Climate and Energy Solutions

Investment in clean energy ETFs like ICLN is a long-term investment. You will have to wait for more people and countries to adopt new technologies into their core infrastructures. That takes time and money. ICLN is not U.S focused which we can view as a positive or a negative, depending on your strategy. International exposure is great for diversification. Also if we consider how well the oil industry protects itself in the United States, the move to other energy sources might happen in other countries quicker than in the United States.

US Electricity generation by fuel

Renewable energy starts to make more and more economic sense. A positive trend in the industry is that these energy sources are becoming cheaper and cheaper.

The cost of large-scale solar projects has plunged 85% in a decade.

This is fuelling the rise of renewables as the world’s cheapest power.

Source: Renewables Were the World’s Cheapest Source of Energy in 2020

While scientist debate whether these sources are actually benefiting the planet, economics start to make more sense. This alone is encouraging that the growth will continue. We are in the early days still so technology will only improve. So while the performance hasn’t been phenomenal in the past, I do see the future being different.

Solar ETFs

Solar is the subset of the renewable energy sector. As of 2020, Solar represents just 1.32% of U.S energy consumption by energy source.

US primary energy consumption by energy source in 2020

That said, the industry is seeing growth as the prices of solar continue to decline.

Cumulative US Solar installations

Source: Solar Industry Research Data | SEIA

Invesco’s Solar ETF – TAN is the biggest ETF focusing specifically on solar companies. ETF does suffer from top-heavy concentration, but at the same time, it is a very specialized ETF, so it makes sense that there aren’t too many big solar companies to provide ample diversification.

TAN top holdings

TAN vs ICLN

I want to compare a hypothetical $10,000 investment in Invesco’s Solar ETF – TAN vs Shares Clean Energy ETF – ICLN. We know that generally ICLN had really poor performance over the last 10 years until 2020 where it took off so I expect the same result for TAN.

TAN vs ICLN 10k investment

Results are as expected with ICLN slightly doing better than TAN.

Fees

TAN vs ICLN Fees

TAN is also slightly more expensive with an Expense Ratio of 0.69% compared to 0.46% for ICLN.

Unless you are specifically looking to invest in Solar, at this point in time, I would pick ICLN over TAN. You get a better-diversified ETF with exposure to Solar energy but also other clean technologies. It is slightly cheaper and has historically performed better.

ESG Funds perform better over the long run

The reason I wanted to break down the whole ESG fund sector into individual funds is because I often hear a claim that ESG funds tend to perform better. However, markets are not that binary. Yes, some clean technologies have delivered impeccable results but others have not. Not all ESG-friendly companies are made the same. Stock market is a market of individual stocks, we must remember that. So when looking for investment opportunities, we need to look at them on individual basis as well as part of their industries, and the world as a whole.

The whole concept of ESG is subjective. MSCI has clearly defined what they call ESG but companies can manipulate metrics that make them more ESG-friendly without necessarily changing how they operate at the core. That is not a bad thing in the end. Companies might start manipulating some of these metrics but over time, hopefully it will be easier to actually implement some of the changes rather than simply virtue signal.

Happy Investing!

Top EV ETFs Breakdown

I started my professional career in the automotive industry long before electric vehicles were a thing despite Tesla already existing.

Pin It on Pinterest

Share This