It used to be that companies involved in clean energy were easy to spot because they were either a solar energy player or a wind energy player. Investing in these two spaces also used to be a lot easier since the 2008 launch of the then-named Guggenheim Solar ETF, now called the Invesco Solar ETF (TAN) after some ETF industry acquisition activity, and the First Trust Global Wind Energy ETF (FAN).
These two funds were predated by the 2005 launch of the then-named PowerShares Wilderhill Clean Energy Fund from the pioneering thematic issuer PowerShares, which was also acquired by Invesco and now trades as the Invesco Wilderhill Clean Energy ETF (PBW). While there were some follow-on products from other issuers like the iShares Global Clean Energy ETF (ICLN) in 2008 and the First Trust Nasdaq Clean Edge Smart GRID Infrastructure Index Fund (GRID) in 2009, there really hasn’t been a lot of product innovation in the renewables space since then.
To be clear, there have been a lot of environmentally focused funds launched since then, but I tend to discount many of these strategies. Let me tell you why.
The Great Greenwashing
In the early 2010s, the idea of Environmental, Social, and Governance (ESG) awareness began to take hold and we started to see companies make public statements about steps they were taking to be better corporate citizens. Investors generally like to see quantifiable proof to back up investment strategy decisions and these statements gave analysts and product development groups the justification they needed to get to work on creating a host of new products.
Simply put, ESG ratings and rankings allowed just about every company to claim its place on the environmental awareness spectrum. More data is generally better than less data, but what ended up happening was that ESG data was being applied to various existing strategies with little, if any, regard for the spirit of what should differentiate an ESG-focused portfolio from a legacy approach.
If a group of oil majors issues ESG statements, then guess what, that’s enough for a lot of fund issuers to include those companies in their ESG-focused funds. Similarly, companies in the semiconductor fabrication space have historically been on the “wrong” side of the issue of water scarcity yet stating that they are planning to “do better” is enough to merit inclusion in any number of ESG products.
For example, one ESG ETF counts perennial number one ranked global polluter Coca-Cola as a top holding and also includes Exxon Mobile, Chevron, Conoco Phillips, as well as chip makers Nvidia, Advanced Micro Devices, NXP Semiconductors, and Intel. To be clear, I am not saying these names are bad investments but the idea that they merit inclusion in what is marketed as an ESG portfolio (aware or not) is, as they say, dubious.
In fact, things are so out of hand that the SEC is in the process of working on Climate-Related Disclosures/ESG Investing rules, set to be finalized sometime in 2023. Another “we’ve hit the top” signal is credit rating agency Standard & Poor’s recent announcement that it will no longer be issuing “ESG credit indicators," discontinuing the metric it developed and started using in 2021. They are not scrapping ESG analysis entirely, but are stepping back from issuing specific ESG ratings.
Full Circle and Then Some
What started out as Alternative Energy investing was really the start of what we would now call the de-carbonization movement. We got a little lost along the way with ESG-mania but the reclaimed/recycled silver lining of that mania is the idea of what is now referred to as Sustainable Investing.
De-carbonization used to focus solely on non-fossil fuel-based energy generation but has since been expanded to include the discovery and use of hydrocarbon substitutes like recyclable materials instead of plastic. Sustainable investing expands that scope further by focusing on not just the avoidance of producing and using environmentally harmful products, but minimizing the environmental impact of the production and use of all products.
One tool that has been developed to assess the sustainability and environmental impact of companies is the Greenhouse Gas Protocol and its 3-tiered greenhouse gas (GHG) inventory methodology, as explained on this US Environmental Protection Agency website:
- Scope 1 emissions focus on the emissions required to produce the company’s goods.
- Scope 2 emissions focus on any upstream activities including the production and transportation of raw input materials.
- Scope 3 emissions focus on downstream activities like distribution, use of the product(s), and what happens once the product has reached the end of its usefulness to name a few of the captured metrics.
Tracking GHG emissions is a great start to being able to identify companies that are doing both “well and good.” When it comes to identifying other characteristics that can mark a company as using sustainable practices, that can get a little tricky for investors.
For example, what do you do with a company whose products may not be the best thing from an environmental perspective, but ensures that all company buildings are Leed Certified, or employ waste heat recapture systems to supplement energy needs? It is questions like this that keep index and ETF development teams up at night.
Sorting It All Out
It has been said that the best investment ideas are often those that are simple and straightforward. From my perspective, this is the approach investors should take in evaluating opportunities in the sustainable investing space. The first step is to understand what the security selection process entails.
I have been talking and writing about this for years, but I will say it again: If you are evaluating an index-based fund, find your way to the index methodology guide. A good ETF issuer will have this link on their website while others will at least list the index by name at which point you can Google your way to the index provider’s website.
Actively managed funds will have a good description of their process in the fund prospectus, which per regulation they will have available on their website. Once you have a handle on what the company says it does to select final index constituents or fund holdings, review those holdings and check if what you see lines up with not just what they said about security selection but also how the fund is positioned.
Fund names that include phrases like “Climate Conscious,” “Transition,” or ‘Aware” should be indicators to you that the product is most likely a modified or rebranded version of an existing core product already launched by that issuer.
Old School and New School
The funds mentioned at the beginning of this article are still around and make for solid choices when it comes to investors looking for targeted exposure to alternative energy. Other funds I have found to be interesting from a targeted exposure perspective include:
- Engine No. 1 Transform Climate ETF (NETZ)
- Invesco MSCI Sustainable Future ETF (ERTH)
- IQ Cleaner Transport ETF (CLNR)
- SoFi Smart Energy ETF (ENRG)
While ESG as a marketing term has begun to lose its appeal, the underlying principles still have merit. That we now talk about Sustainable Investing shouldn’t diminish the idea of what ESG investing was supposed to stand for.
With that in mind, stepping away from the “E” in ESG, Sustainability also has to do with the planet’s most valuable asset, its people. To that end, there are a growing number of funds out there that focus on the development and growth of not just people, but countries as well. This group includes funds like:
- Hypatia Women CEO ETF (WCEO)
- Harbor Corporate Culture Leaders ETF (HAPY)
- Freedom 100 Emerging Markets ETF (FRDM),
- and, if only because Islamic Finance puts more emphasis on shared upside participation and is overall more supportive of borrowers than traditional finance, the Wahed FTSE USA Shariah ETF (HLAL)
To be clear, these are not investment recommendations. If you are interested in learning about what innovations have been happening in the ETF industry and the sustainable investing space, these funds are a good place to start.
If you do decide to consider any of these funds for investment, understand that while some may be on the small side from an AUM perspective, ETF liquidity is above all, about the liquidity of the holdings in the fund, and not the fund itself, but that is a topic for another day.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Mark Abssy
Mark Abssy is Head of Indexing at Tematica Research focused on index and Exchange Traded Product development. He has product development and management experience with Indexes, ETFs, ETNs, Mutual Funds and listed derivatives. In his 25 year career he has held product development and management positions at NYSE|ICE, ISE ETF Ventures, Morgan Stanley, Fidelity Investments and Loomis Sayles. He received a BSBA from Northeastern University with a focus in Finance and International Business.
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