ESG ETFs: Exception or the norm?

By Andrea Semino, Senior Product Specialist, Credit Suisse Asset Management

Many commentators have called sustainable investing the biggest product innovation of the last decade in the professional asset management industry. Sustainable investing, or investing that takes environmental, social, and governance (ESG) factors into account, is not, however, a completely new idea.

One prominent example dates back to the 1980s, when the endowments of major universities in the United States divested from South African companies to challenge the apartheid regime. This was just a set of investment restrictions applied by ethical investors rather than a systematic approach aiming to improve the ESG profile of the portfolios – but it sent a clear message.

Investor preferences and regulation driving change

The major shift began about 15 years ago, when several asset managers introduced basic but systematic exclusion-based products to a wider investor base. This included rigorous ESG scoring schemes, which couple well with the process of constructing quantitative ETF portfolios, spurring strong growth of ESG-themed and ESG-integration products. Globally, Europe remains the leading end market for passive funds and sustainable ETF/ESG products, accounting for more than three-quarters of the global market.

It was a combination of investor preferences and an increasingly robust regulatory framework that spurred the rapid proliferation of ESG products in the European market.

With the inception in 2021 of the Sustainable Finance Disclosure Regulation (SFDR), a European Union law defining a common taxonomy for ESG investments, all asset managers reclassified their product range into three categories:

• Products without sustainability goals (art. 6).

• Products that promote social and environmental initiatives along with traditional performance objectives (art. 8).

• Products with solely ESG objectives (art. 9).

The chart illustrates the growing importance of sustainable investments within the European ETF industry. While sustainability-conscious strategies (art. 8 and art. 9) accounted for less than one-fourth of assets under management as of the end of 2021, they sparked 60% of total inflows and 58% of new ETF launches between 2020 and 2021.

While ESG Leaders is our main strategy for ESG-indexed equity ETFs, we sometimes opt for different approaches in particular asset classes. One example is listed real estate investment trusts (REITs), where opportunities to make tangible improvements in the environmental sustainability of portfolios are abundant. Our CSIF (IE) FTSE EPRA Nareit Developed Green Blue UCITS ETF¹ identifies the highest-efficiency REITs, drawing on a database of over 70,000 buildings, and then over weights them in the portfolio in order to reduce CO2 emissions per square meter compared to the original index.

Potential risks

• Potential loss: Investors may lose part or all of their invested amount.
• Market risk: Market conditions can trigger fluctuations in total returns.
• Liquidity risk: Some investments may entail liquidity risk.
• Foreign currency risk: The fund’s total return can be adversely affected by exchange rate fluctuations.

With investor demand growing and regulators aiming to incorporate sustainability considerations into the wealth management process, we expect this trend to continue. In the future, ESG could become the norm rather than the exception. Sustainable ETFs will also benefit from the evolution of asset classes through adopting an environmental perspective. For example, 30% of the EUR 750 bn included in the NextGenerationEU program will be financed through green bonds. This is a prime example of where the industry is headed.

The drivers of this success can be found both in the main advantages of passive investments over active ones (e.g. lower costs, predictability of performance, high diversification) and in greater objectivity in the application of sustainability/ESG criteria, which is only possible through a quantitative approach. By indexing ESG-type exposures, sustainability ratings become part of the investment process while simultaneously helping to determine the weighting of each security in the index.

Sustainability in the spotlight

Building a sustainable product offering

At Credit Suisse Asset Management, we develop our sustainable index offering around the MSCI ESG Leaders methodology, a two-stage technique that is proving to be the most popular standard among institutional investors.

For our equity ETFs, we rely on the MSCI ESG Leaders methodology, which aims to filter the reference investment universe by not considering certain sectors, such as coal mining, shale oil and gas extraction, and other controversial business

practices. The remaining securities are sorted by their sustainability rating, and only the top 50% within each sector are kept in the portfolio.

Taking our CSIF (IE) MSCI World ESG Leaders Blue

UCITS ETF¹ as an example, the total number of securities is reduced by more than half, from about 1,600 to 680, allowing investors to benefit from significantly improved ESG metrics without excessive portfolio concentration.

Securities lending ruled out

Another relevant ESG consideration is the role of securities lending. With securities lending, the fund manager makes the securities in the portfolio available to third parties to carry out short sales in return for remuneration that is credited to the NAV of the fund. For the period in which they are lent, the fund manager transfers the usufruct rights of the securities, including voting rights, effectively making it impossible to operate an engagement program with the investee company.

For consistency, we have decided to exclude securities lending across our entire ESG product range, as giving up the voting rights can undermine the ESG concept. To make this clear, we include the term “blue” in the names of the relevant Credit Suisse Asset Management index funds and ETFs.

Conclusion

The incorporation of ESG into investment processes and decisions is an accelerating trend and is here to stay. We believe that the mix of regulatory push and changes in investors’ preferences will continue to “nudge” asset allocation choices toward greater social and environmental awareness, changing the structure of the ETF industry as we know it.

¹ETF: bid-ask spreads apply. Listed at SIX, Deutsche Börse, and Borsa Italiana.

This is a marketing communication. For Institutional/qualified investors only. Please refer to the prospectus/information document of the fund and to the KIID/KID (as applicable) before making any final investment decisions.

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The investment promoted in this marketing material concerns the acquisition of units or shares in a fund and not of any underlying assets. The underlying assets are owned by the fund only.

ESG stands for environmental (E), social (S), and governance (G). For further information about the ESG investment criteria and the sustainability-related aspects of the fund please consider the legal and regulatory documents of the fund (such as, e.g., the prospectus) and visit credit-suisse.com/esg. In addition to sustainability-related aspects, the decision to invest in the fund should take into account all objectives and characteristics of the fund as described in its prospectus, or the information which is to be disclosed to investors in accordance with applicable regulations.

Source: Credit Suisse, unless otherwise specified.

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