In response to changes in public attitudes and regulations, many companies are developing their own environmental, social, and governance (ESG) approaches. They are also reevaluating their sustainability priorities. We believe such changes fit well with the increased appetite of investors for ESG products. We expect demand to be met by a steady rise in sustainability-related investment solutions, including ETFs.
Globally, the market for exchange-traded funds has continued to grow at pace. It is particularly buoyant in Europe where Exchange Traded Funds (ETFs) now account for roughly 15% of all UCITS[1] pooled investment vehicles, holding an estimated EUR 1.9 trillion of assets under management.[2]
As the market has grown, so has the universe of ETF solutions available to investors. The breadth of ETF coverage means they can be important building blocks ‒ as both core and satellite allocations ‒ for portfolio managers and help investors construct portfolios that are tailored to meet their financial goals, but also increasingly their extra-financial objectives.
The rise of ESG investing
Since the 2015 Paris Agreement on climate change, there has been a notable increase in global demand for sustainability-geared investment solutions that incorporate ESG factors alongside traditional financial metrics. If we consider ETFs, assets under management in Europe dominate, amounting to nearly three-quarters of the global ESG ETF market (see Exhibit 1).
What are the different approaches?
At present, investors can select from a wide array of ESG ETFs, covering different asset classes, geographies, themes, and sustainable investment approaches.
In line with the EU’s Sustainable Finance Disclosures Regulation (SFDR), ETFs qualify for sustainability-related classifications such as Article 8 or Article 9. Within those categories, some ETFs apply stringent criteria, others may have a sustainable thematic approach, and some concentrate on improving ESG characteristics against a stated benchmark.
We call these different approaches ‘shades of green’. They include ‘light green’ ETFs which avoid investing in companies with poor ESG scores and apply a normative and sector exclusion as part of the selection process. Darker green ETFs have sustainability-related objectives such as advanced decarbonisation or invest exclusively to finance environmental and/or social projects.
Increased selectivity typically results in a higher tracking error relative to the initial investment universe.
[1] See https://www.investopedia.com/terms/u/ucits.asp
[2] Bloomberg, as of 08/10/2024
