After a multi-year run of success, environmental, social and governance (ESG) exchange traded funds fell on hard times in 2022 and there are several factors explaining that weakness. But first, let's explain what ESG ETFs are.
What are ESG ETFs?
ESG ETFs are one way investors can align their financial goals with issues most important to them. These ETFs embody Environmental, Social and Governance initiatives and incorporate each into a uniform investment approach.
For starters, many ESG ETFs – particularly the older, large-cap funds in the category – are chock full of growth, which are being punished by rising interest rates. Second, it’s not just that growth stocks and funds are faltering. The added drag on ESG ETFs is that many asset allocators are rotating out of those assets into value strategies.
Finally, as is to be expected, ESG ETFs are light on energy stocks and that’s problematic when energy as the best-performing sector in the S&P 500 for the second consecutive year. Still, ESG remains a popular concept among market participants. Although inflows into ESG ETFs are slowing this year – the result of a languishing equity market – the flows are still positive.
Further underscoring the long-term prospects for ESG as an investment concept is the point that more companies are prioritizing this issue.
“Some 90% of companies either have or are developing a formal strategy to manage corporate environmental, social, and governance practices, according to a Morningstar Sustainalytics survey of 556 corporate social responsibility and sustainability professionals,” notes Morningstar analyst Allie McCallion.
Plus, a variety of factors point to some of the following ESG ETFs being potential 2023 rebound candidates.
Three ESG ETFs to Watch in 2023
XTrackers S&P ESG Dividend Aristocrats ETF (SNPD)
The XTrackers S&P ESG Dividend Aristocrats ETF (SNPD) is barely more than a month old, making it one of the newest ESG ETFs on the market, but thanks to the dividend overlay, SNPD is also immediately relevant because payouts are growing and dividend stocks are outperforming this year.
This newly minted ETF follows the S&P ESG High Yield Dividend Aristocrats Index, which mandates that member firms have minimum dividend increase streaks of 20 years. Adding to the allure of this new ESG ETF is the potential for long-term out-performance relative to the broader market.
“Recently, the outperformance of the S&P ESG High Yield Dividend Aristocrats Index versus the S&P 1500 has been even more pronounced," noted S&P Dow Jones Indices. "Year-to-date, the S&P ESG High Yield Dividend Aristocrats Index has outperformed the benchmark by 15.25%. One reason for this is that high-yielding indices, mainly through their lower durations, offered greater protection against rapidly rising interest rates compared to the benchmark."
Invesco ESG NASDAQ 100 ETF (QQMG)
As noted above, many ESG ETFs are heavy on growth stocks and that’s certainly true of the Invesco ESG NASDAQ 100 ETF (QQMG). Earlier this year, QQMG could have been seen as a risky proposition for investors, but that risk is now significantly diminished.
Adding to the case for QQMG are the points that many of its holdings are deeply discounted relative to historical norms and have quality traits. Those include Apple (AAPL), Microsoft (MSFT), and Alphabet (GOOG). Put it altogether, QQMG has the makings an ESG ETF appropriate for long-term investors.
“For ESG, we’re talking about longer-term strategies," noted Lauren Puffer, head of sustainability banking at Cowen. "ESG includes the way that companies are looking at environmental impacts, social impacts, and their governance structures today, and making decisions about that that will impact the companies and potentially, their value over the longer term."
IQ MacKay ESG Core Plus Bond ETF (ESGB)
As is the case with growth stocks, bonds are being taken to the woodshed this year, which isn’t surprising given that the Federal Reserve raised interest rates six times. However, some market observers believe they are poised to rebound next year, indicating there could be value in the IQ MacKay ESG Core Plus Bond ETF (ESGB).
ESGB is actively managed, which could prove to be a critical trait due to the dearth of bonds with legitimate ESG credentials on the market today. Plus, this ESG ETF is growing rapidly as approximately 90% of its assets under management have flowed into the fund just this year. Data indicate some investors may be ditching mutual funds for ESG ETFs such as ESGB.
“This year is shaping up to be the biggest ‘wrapper swap’ on record," reports The Wall Street Journal. "Roughly $454 billion has been pulled from bond mutual funds on net while $157 billion has entered bond exchange-traded funds through the end of October. That would be the largest net annual swing toward ETFs by a wide margin, according to Strategas."
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Todd Shriber
Todd Shriber got his start in financial markets as a reporter with Bloomberg News. Later, he became a trader at a Southern California-based long/short hedge fund where he specialized in trading sector and international ETFs leading up to and during the financial crisis. He would later become the web editor at ETF Trends. Currently, he analyzes, researches and writes on ETFs for a variety of Web-based publications and financial services firms.Shriber has been quoted in the Barron's, CNBC.com and the Wall Street Journal. His work has been published on Web sites such as Benzinga, ETF Daily News, ETF Trends, MarketWatch, Fox Business and Nasdaq.com.
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