The Problem With Broad ESG ETFs – How To Choose More Sustainable Stocks For Your ESG Portfolio
The largest ESG ETFs have weak ESG criteria and resemble regular large and broad ETFs. To differentiate your investments, look for more sustainable alternatives. Chose stocks of companies with great reputation and low ESG risk ratings
As we have demonstrated before, sustainable investors need to be extra careful when selecting broad mainstream ESG ETFs. Those ETFs tend to have weaker investment strategies and are not very strict when selecting their holdings.
We will investigate the largest ESG ETFs available in the market, compare their holdings and show how investors can choose more sustainable stocks to be part of their ESG portfolio.
The largest and most popular ESG ETFs
In the USA, the largest ETF providers are Blackrock, Vanguard, State Street (SPDR), and Invesco. While in Europe, the largest ETF providers are Blackrock, Lyxor, and Deutsche Asset Management (DWS). Among the ETF products of those providers, we can find the largest ESG ETFs currently available in the market for retail investors.
The largest ESG ETFs from the top ETF providers with at least USD 1 billion in AUM are:
- iShares ESG Aware MSCI USA ETF (ESGU)
- Vanguard ESG U.S. Stock ETF (ESGV)
- Xtrackers MSCI USA ESG Leaders Equity ETF (USSG)
Note: State Street launched its ESG ETF, the SPDR S&P 500 ESG ETF (EFIV), in July 2020. The ETF has only USD 224 million in assets under management and have not been considered in this analysis.
Below we have a few more details of the largest ESG ETFs:
|Name||iShares ESG Aware MSCI USA ETF||Vanguard ESG U.S. Stock ETF||Xtrackers MSCI USA ESG Leaders Equity ETF|
|AUM (billion USD)||17.4||4.2||3.7|
|MSCI ESG Rating||A||BBB||A|
|Number of holdings||351||1465||298|
|Weight of top 10 holdings||24.50%||27.5%||31.45%|
We have previously looked in-depth into Vanguard ESG U.S. ETF (ESGV) and concluded that it is not a good ESG ETF for sustainable investors. That can also be deducted from its MSCI ESG Rating of ‘BBB’.
When looking at iShares ESG Aware ETF (ESGU) and Xtrackers MSCI USA ETF (USSG), we should expect a better sustainable performance, since both have better MSCI ESG ratings, ‘A’.
Let us take a deeper look and compare the top holdings of the largest ESG ETF: ESGU, ESGV, USSG.
Top ESG stocks or simply larger market capitalization?
Are the top 10 holdings of the ESG ETFs carefully selected based on the companies ESG performance or do they simply reflect the companies with the largest market capitalization?
Due to the similar and weak ESG strategies, the ESG ETFs ESGU, ESGV, and USSG, have extremely similar top 10 holdings:
|Top 10 holdings||ESGU||ESGV||USSG|
|#1||Apple Inc.||Apple Inc.||Microsoft Corp.|
|#2||Microsoft Corp.||Microsoft Corp.||Alphabet Inc. Class A|
|#3||Amazon.com Inc.||Amazon.com Inc.||Alphabet Inc. Class C|
|#4||Facebook Inc.||Alphabet Inc.||Tesla Inc.|
|#5||Alphabet Inc. Class C||Facebook Inc.||Johnson & Johnson|
|#6||Alphabet Inc. Class A||Tesla Inc.||Visa Inc.|
|#7||JPMorgan Chase & Co.||JPMorgan Chase & Co.||NVIDIA Corp.|
|#8||Tesla Inc.||Visa Inc.||Home Depot Inc|
|#9||NVIDIA Corp.||UnitedHealth Group Inc.||Procter & Gamble Co|
|#10||Johnson & Johnson||NVIDIA Corp.||Walt Disney Co|
The top 10 holdings of those ESG ETFs is also extremely similar to the top 10 holdings of regular broad ETFs. In this case, the top ESG ETFs, with exposure to the US, include most of the largest companies by market cap, including the classic FAANG stocks or the “big tech” companies.
Microsoft, Alphabet, Tesla, and NVIDIA are present in all three ETFs, while the remaining 6 ETFs from ESGU are present at least one more time in either ESGV or USSG ETFs.
Out of the total 30 stocks in the 3 ETFs top 10, four stocks appear one time only: United Health Group, Home Depot, Procter & Gamble, and Walt Disney.
If those top 10 holdings have indeed good ESG ratings, then we could assume that Blackrock, Vanguard, and DWS are doing a good job when creating their ESG ETFs.
Let us see how those stocks perform on ESG criteria and risk ratings.
ESG analysis of a typical ESG ETF top holdings
|Common Top 10 Holdings||Sustainalytics||MSCI|
|Apple Inc (AAPL)||16.9||BBB|
|Microsoft Corp. (MSFT)||14.6||AAA|
|Alphabet C (GOOG)||22.3||BBB|
|JPMorgan Chase (JPM)||28.2||BBB|
|Johnson & Johnson (JNJ)||29.0||BBB|
Among the 10 most common stocks, we can see a large disparity of ESG risk ratings. From low ESG risk of 12.6 for NVIDIA to high ESG risks of 31.3 for Tesla and 27.3 for Amazon.
Except for Apple, Microsoft, NVIDIA and Visa, all other stocks have medium to high ESG risk ratings (above 20 points). Not what you would expect from a good ESG ETF.
Let us see how to improve the ESG performance by selecting more sustainable stocks.
Which stocks are more sustainable than ESG ETFs top holdings?
Using the Sustainalytics ESG Risk Rating tool, we will look for stocks that are comparable to the top stocks listed above, in the same industry, but with lower ESG risk, and consequently, better ESG ratings.
A more sustainable alternative to Apple (APPL) in the technology hardware industry
With an ESG risk rating of 16.9, Apple is seen as low risk by Sustainalytics. However, MSCI gives an ESG rating of BBB. A better alternative in the technology hardware industry is Hewlett-Packard (HP). The computer hardware company has an ESG risk rating of 10.2 from Sustainalytics, and an MSCI ESG Rating of ‘AA’
More sustainable alternatives to Microsoft (MSFT), Facebook (FB), Alphabet (GOOG/GOOGL), and Visa (V) in the software & services industry
Four of the top 10 stocks are companies operating in the software & services industry. Microsoft and Visa have low ESG risk ratings of 14.6 and 17.4 respectively. On the other hand, Facebook and Google have medium ESG risk ratings of 24.8 and 22.3, respectively.
Microsoft has a good ESG performance, but alternatively, it could be replaced by Adobe, which has an ESG risk rating of 10.9
Mastercard, Visa’s direct competitor, has a slightly better ESG risk rating, 16.3. In this case, both companies have a similar sustainability performance.
A more sustainable alternative to Amazon (AMZN) in the retail industry
Amazon is not the best option among stocks in the retail industry. We have previously presented some of Amazon’s ESG issues. The company has an ESG risk rating of 27.3 and an MSCI ESG rating of ‘BBB’. Better alternatives are Best Buy (13.7) and Target (15.0)
A more sustainable alternative to JPMorgan Chase & Co. (JPM) in the bank industry
Finding sustainable companies in the bank industry is not an easy task. Despite good performances on the Environment criteria (low direct emissions), banks usually have worse ratings for the Social and Governance criteria.
In this specific case, an American bank that could work as an alternative to JPMorgan is The PNC Financial Services Group., which has an ESG risk rating of 22.5.
We previously wrote about sustainable banks. However, most of the banks listed in this article are not publicly listed companies.
A more sustainable alternative to Tesla (TSLA) in the automobiles industry
Tesla has the worse ESG risk rating among the top 10 stocks listed above. Tesla has an ESG risk rating of 31.3, which is classified as a high risk by Sustainalytics. You can read our full analysis of Tesla ESG performance here.
A good alternative to Tesla is Harley-Davidson. The famous motorcycle company has an ESG risk rating of 16.4.
A more sustainable alternative to NVIDIA (NVDA) in the semiconductors industry
The semiconductors industry is highly competitive when it comes to ESG scores. We couldn’t find another American company with an ESG risk rating better than NVIDIA’s 12.6 and MSCI ESG ‘AAA’.
A more sustainable alternative to Johnson & Johnson (JNJ) in the pharmaceuticals industry
Johnson & Johnson has a medium-high ESG risk rating of 29.0 from Sustainalytics and an MSCI ESG rating of ‘BBB’. An alternative to the largest American pharmaceutical and consumer goods company is the smaller Illumina (ILMN). The biotech company has an ESG risk rating of 11.2 and is number one in Sustainalytics’s industry ranking.
The largest ESG ETFs, iShares ESG Aware MSCI USA ETF (ESGU), Vanguard ESG U.S. Stock ETF (ESGV) and Xtrackers MSCI USA ESG Leaders Equity ETF (USSG), have weak ESG strategies and, consequently, their holdings are highly correlated to the holdings of most broad non-ESG ETFs.
The stocks with the largest market cap do not necessarily have good ESG ratings. Instead of investing in the classic blue chips, we brought alternative stocks that have lower ESG risk ratings and better MSCI ESG ratings.
Hewlett-Packard (HP), Adobe (ADBE), Mastercard (MA), Accenture (ACN), Salesforce (CRM), IBM, Best Buy (BBY), Target (TGT), PNC Financial Services (PNC), Harley-Davidson (HOG), and Illumina (ILMN) are all stocks with lower ESG risk ratings that can work as an ESG alternative to the standard top 10 holdings of broad ESG ETFs.
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