ESG ETFs aren't what they seem

Mike Zaccardi, CFA, CMT

Environmental, Social, and Governance (ESG) funds are marching higher, despite COVID-19 impacts. Whenever a factor is performing well (or poorly), it’s important to review the sector allocation. Sector weights drive returns, yet few market participants realize it.

I took a look at the S&P 500 ESG ETF (SNPE). Though this ETF does not have a ton of assets, it’s a good representation of what comprises the ESG factor in the US stock market. What sector do you think dominates the mix? Energy, utilities, industrials? Nope. Technology.

We all know how mega-cap technology growth stocks have led the stock market higher in the last 10 years, and that theme has continued in 2020. COVID or no COVID. Technology makes up 28% of SNPE followed by healthcare (of all sectors!) at 15%. Energy stocks are just 3% of the ETF. Utilities are also just 3%.

It’s a little bit of smoke (no pun) & mirrors when it comes ESG’s outperformance. So long as QQQ (the tech heavy NASDAQ 100 index fund) is outperforming, so too will ESG funds. Microsoft, Apple, Amazon, Google, Facebook are among the biggest holdings across the ESG fund spectrum.

As a technical analyst, I also enjoy looking at ratio charts. Ratio charts are simply dividing one asset by another, then comparing the trend. In this case, I like to review the ratio chart of the world ESG leaders to the global stock market index.

I write at TopDownCharts.com, and each week Callum Thomas prepares a useful chartbook for investors – one of the charts is the MSCI World ESG Leaders Relative chart – displayed within this article. ESG stocks have been beating the global equity market for several years, though there was a downward move (versus other stocks) from early 2016 to the end of 2018.

So be sure to check your sector weights when doing fund analysis – it makes all the difference.

Chart from Topdowncharts.com

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