Head of Exchange Traded Products Nick Cherney discusses the growing interest in environmental, social and governance (ESG) investing and why he believes active management coupled with the efficiency of the exchange-traded fund (ETF) structure can help investors build sustainable portfolios.

Key Takeaways

• In recent years, we have seen accelerating interest among investors seeking to align their financial objectives with their views on sustainability.
• However, we feel there is currently a gap in the market for sustainable ETFs that incorporate the more detailed level of analysis that active management can provide.
• Historically, the concern has been that focusing on ESG meant sacrificing returns. But we believe it is possible to deliver best-in-class risk-adjusted returns while also meeting a high standard in terms of sustainability.

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I think what we’ve seen evolving obviously over decades, but then really accelerating over the last couple of years, has been increased, I would call it sort of bottom-up interest, awareness and demand for aligning one’s investments with, you know, one’s views on sustainability on ESG topics across the board. And so as a result of that, I think there is this pretty significant increase in an understanding that one’s investment objectives don’t have to conflict with one’s other objectives. And in fact, in many cases, ESG strategies, whether it’s within equities or fixed income, can successfully deliver returns that are comparable with funds that don’t have an ESG initiative.

I think honestly, one of the biggest challenges today for people who are starting to think really critically about how they can build ESG portfolios is that most of the products fall into two categories that might not meet their needs. So the first category is dedicated ESG specialist firms who do a fantastic job in many cases on really digging in on the complex issues related to sustainability within companies themselves, but often leave out the investment results as sort of a derivative or residual of that process.

The second category, of course, is the growth of passive ESG. And unfortunately, a lot of those products really stop at the first step of the process, which is negative screening. And so while they do screen out, based on third-party data, for certain companies and industries that are maybe unacceptable to ESG investors, we really think that to deliver ESG in a credible way, requires you to go beyond that.

Where we see a real gap so far in the market is in sustainable ETFs that provide the sort of detailed analysis that active management provides.

I think for most advisors, historically the concern has been that focus on ESG has meant sacrificing returns. But I think that that dichotomy is really starting to fall apart, and so advisors today certainly can select investments that will deliver risk-adjusted returns, build robust portfolios and meet a high degree or a high standard on the ESG front. And so I think for a lot of advisors, the question has started to become, “Why wouldn’t I incorporate ESG? If I can get similar returns, if I can meet the objectives of my clients from a financial perspective, but also really help to align their investment goals with the priorities that they have in the rest of their life, then why wouldn’t I?” So I really think it comes down to the ability to focus on high-quality, risk-adjusted returns within an ESG framework, and you really can meet both of those objectives simultaneously by carefully selecting well-built product.

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