The market for ethical or environmental, social and governance (ESG) exchange-traded funds (ETFs) has grown exponentially in recent years, attracting investors who want to align their money with opportunities that are consistent with their core values and beliefs.
The trend towards investing in ESG - also known as Socially Responsible Investment (SRI) - has long been favoured in Europe, and it is now rising amongst U.S. investors, largely due to the increasing influence of Millennial and Generation X investors as they begin to enter into their prime earning years. The beauty of the ETF wrapper is that it has democratised investing to the point that these investors can put their money behind ESG themes with ease. In fact, just this past month, DWS launched the largest1 ESG ETF in the U.S. in the last 15 years. ETFGI recognised this trend and released a recent report specifically on ESG investing in the ETF / ETP (Exchange-Traded Products) sector. In 2018, ESG ETFs/ETPs assets increased 29.51%, representing $7.61bn2 in net new assets. When comparing that to the overall asset increase in ETFs/ETPs of 4.6%, this increase is exceptional.
We believe there are three factors that place ETFs in a prime position to continue being the ESG “vehicle of choice” and capture this growth trajectory within ESG investing:
• Transparency. ETFs by their nature offer transparency, thus allowing investors to validate that the holdings match their beliefs with clear evidence of an ESG focus.
• Low Cost. Based on our recent ETF survey, low-cost investment vehicles continue to be a key factor for investors.
• Technology. Available technological tools level the playing field for all investors. The ease of trading that an ETF offers Millennial and Generation X investors helps them access the investment strategies they demand.
Focusing on ETF issuers in this space, Ossiam gained headlines in late 2018 as the first European asset manager to launch a smart beta ESG ETF which uses a machine learning algorithm - Ossiam World ESG Machine Learning UCITS ETF - to rank companies based on their ESG status and financial potential, one of many ESG strategies offered by Ossiam.
According to Ossiam, the investment process begins with an ESG filter, applied to a universe of globally developed large cap equities. Companies that do not comply with the 10 principles of the UN Global Compact are excluded as an example. The United Nations Global Compact is a non-binding United Nations pact to encourage businesses worldwide to adopt sustainable and socially responsible policies, and to report on their implementation. By adopting this process, Ossiam has developed a strategy that has improved the ESG rating process and also reduced its carbon footprint, a feature investors are increasingly seeking to achieve through their investment allocation decisions.
"Investors are continuously expanding their allocation to ESG funds. But the question whether ESG is a driver of performance remains mostly unanswered" says Carmine de Franco, Head of Fundamental Research at Ossiam. "At Ossiam we believe that simple ESG screenings are good to produce impact and improve the portfolio’s ESG performance, but not to enhance performance in a systematic way. Nevertheless, there is overwhelming evidence that ESG and performance are linked, the point is that aggregated ESG scores usually miss this link. Therefore, we have designed a Machine Learning algorithm that is able to identify ESG patterns and profiles of companies that represent an opportunity or a risk from a financial perspective. Our innovative approach to ESG allows us to extract useful information from the data, in a way that a human could not. The power of the Machine Learning, which evolves over time and is self-taught, brings significant value to the strategy in terms of both performance and risk. This will be key, in our opinion, in the coming years, because the growth of ESG investment solutions is expected to be very strong, and investors will need both ambitious ESG policies and robust risk/return profiles."
With some estimating that ESG assets will comprise two-thirds of assets managed by global funds by 20203, this is a trend that is set to continue and ETFs are in a prime position to benefit from this growth well into the future.
 Source: ETFGI.com. Largest is defined by the ETFs initial AUM on the day of listing;
 Source: January 2019. ETFGI.com. “ETFGI environmental, social and governance ESG ETFs and ETPs”
 Pictet Asset Management research cited in https://qz.com/1309419/when-willsocially-responsible-investing-become-just-investing/