Asset and Portfolio Management


ETF Market Making

Sustainable investments in ETFs

Socially responsible investments have become increasingly popular in recent years. Appetite has grown significantly among institutional investors, in particular church organisations, foundations, as well as pension and sovereign wealth funds such as the Government Pension Fund Global of Norway.

There is more to this growing demand than just heightened awareness of ecological, social and ethical behaviour and the stricter rules in place when it comes to the risk management of portfolios. In recent years, market participants have become aware that environmental scandals, image problems and reputational risks all act as a drag on a company's earnings, leading to share price underperformance. Ethical behaviour, it appears, is good for business.


When integrating ethical considerations into the investment process, investors face a bewildering array of industry terms such as ESG and SRI. Socially responsible investing (SRI) is driven by ethical values and excludes specific types of companies based on certain screening criteria that are perceived as negative. In general, this leads to the exclusion of companies that are seen as 'unethical', which can include those affiliated with alcohol, tobacco, nuclear power or fossil fuels.

Environmental, social and governance (ESG) is a rather broad-based approach to identify investment risks (operational or reputational) and opportunities. Rather than prohibiting specific investment areas, the ESG factors of a company are ranked across each industry sector. The rationale behind this is that greater efforts in climate protection, for example, are likely to favour a company’s share price development in the long run.

Furthermore, improved corporate governance and ESG considerations for climate protection, such as the Paris Agreement and the two-degree targeted ceiling in rising global temperature, have driven new regulations. These have spurred moves such as the shutdown of nuclear power stations in Germany and the ban of the sale of gasoline and diesel car after 2030 in Sweden.

One efficient way to invest in socially responsible investments are ETFs. Assets in such ETFs have seen strong growth in recent years. Currently, more than 100 UCITS-compliant ETFs are traded on European exchanges with total assets of more than EUR 8 billion (roughly 88% in equity and 12% in fixed-income ETFs). UBS, iShares and BNP Paribas have been the leading ETF issuers, with other active names including Lyxor, Candriam, Ossiam, Amundi, Xtrackers, VanEck, J.P. Morgan, Deka, Invesco, and Franklin Templeton.

Various indices are available to invest in social responsibility with exchange-traded funds. One of the leading index providers, MSCI, offers a wide range of indices that represent the performance of ESG investment strategies such as ESG Universal, Leaders, Screened and Factor Target as well as SRI and Low Carbon. The key differences between the various index methodologies are the ways in which they choose to exclude companies and sectors, the investors’ objective and the weighting scheme. For example, the MSCI ex Controversial Weapons excludes companies that are involved in the production of cluster bombs, landmines, chemical and biological weapons as well as depleted uranium weapons.


Sustainability indices published by Solactive consist of companies that have been certified with the Oekom 'Prime' status. The index universe is screened for a number of constraints such as controversial business areas including abortion, alcohol, fossil fuels, embryonic research, gambling, military or nuclear power, and practices such as animal testing or human rights.


Low-carbon indices such as the Euronext Low Carbon 100 Europe Index provide exposure to European companies that generate a considerable portion of their revenues from the use of low-carbon technologies, and as such can demonstrate a focus on energy efficiency. Firms involved in various controversial activities are also excluded. Additionally, various thematic indices exist that track the performance of shares that are exposed to social, industrial or demographic trends. One such example is the S&P Global Clean Energy Index, which provides exposure to companies around the world that are involved in clean-energy-related business; another is the S&P Global Water Index, which contains companies purifying and conserving water for homes and industries.

Turning to fixed income, one of Solactive's indices – the Green Bond EUR USD IG Index – contains investment-grade green bonds whose proceeds are dedicated to the financing of green projects focused on climate mitigation or adaptation efforts. Bloomberg Barclays has, together with MSCI, developed a family of fixed-income indices that incorporate measures of ESG risk and exposures. The Bloomberg Barclays MSCI Socially Responsible indices screen out issuers from existing Bloomberg Barclays indices that might be involved in business areas that are in conflict with social norms. In contrast, their sustainability indices positively screen issuers from their existing indices based on best-in-class MSCI ESG ratings.

Last but not least, looking at the flows, Commerzbank, as a leading market maker in European ETFs, executed roughly 28,000 transactions linked to socially responsible investments in 2018, more than double the number placed in 2017. In terms of notional traded, the number actually tripled (see Charts 1 and 2). The flow distribution was in favour of equities (98% share), while fixed income represented around 2% of all trades. The overall trade volume was clearly focused on the buy side. The most traded underlying was the MSCI Europe SRI Index (20.5%), followed by the MSCI ACWI SRI Index (12.7%) and the MSCI Emerging Markets SRI Index (7.6%, see Table 1). On the fixed-income side, the most traded underlying was the Bloomberg Barclays MSCI Euro Corporate 0–3 Sustainable SRI Index.


Chart 1: Notional
Chart 1: Notional
Source: Bloomberg, Commerzbank
Chart 2: Number of trades
Chart 2: Number of trades
Source: Bloomberg, Commerzbank
Table 1: Most traded ETFs linked to ESG/SRI in 2018 with Commerzbank


ETF

ISIN

Index

Replication

TER

UBS Irl ETF plc – MSCI ACWI Socially Responsible UCITS ETF

IE00BDR55F85

MSCI ACWI SRI 5% Issuer Capped

Physical

0.48

iShares MSCI Europe SRI UCITS ETF

IE00B52VJ196

MSCI EUROPE SRI NR

Physical

0.30

UBS ETF – MSCI EMU Socially Responsible UCITS ETF

LU0629460675

MSCI EMU SRI 5% Issuer Capped NR

Physical

0.28

UBS ETF – MSCI USA Socially Responsible UCITS ETF

LU0629460089

MSCI USA SRI 5% Issuer Capped

Physical

0.33

UBS Irl ETF plc – MSCI ACWI ESG Universal UCITS ETF

IE00BDQZN113

MSCI ACWI ESG Universal 5% Issuer Capped

Physical

0.48

UBS ETF–MSCI World Socially Responsible UCITS ETF

LU0629459743

MSCI WORLD SRI 5% Issuer Capped

Physical

0.25

iShares Dow Jones Eurozone Sustainability Screened UCITS ETF DE

DE000A0F5UG3

Dow Jones Sustainability Eurozone

Physical

0.41

iShares MSCI USA SRI UCITS ETF

IE00BYVJRR92

MSCI USA SRI Net Total Return

Physical

0.30

BNP Paribas Easy – MSCI Emerging Markets SRI UCITS ETF

LU1291098314

MSCI EM EMERGING MARKETS SRI

Swap

0.45

iShares MSCI EM SRI UCITS ETF

IE00BYVJRP78

MSCI EM EMERGING MARKETS SRI

Physical

0.35

Deka Oekom Euro Nachhaltigkeit UCITS ETF

DE000ETFL474

Solactive Eurozone Sustainability

Physical

0.40

Sustainable and socially responsible investments have found their way into investors' portfolios. This success story is likely to continue while a growing number of investors incorporate social or environmental aspects in their investment process. Undertaking socially responsible and sustainable investments does not mean having to forgo any return; it can offer the chance of a long-term outperformance, based on the immediately preceding five years (Chart 3). Therefore, it is obvious that the number of ETFs issued and the assets under management will steadily grow in future.

Chart 3: Five-year index performance MSCI Europe NR versus MSCI Europe SRI NR
Chart 3: Five-year index performance MSCI Europe NR versus MSCI Europe SRI NR
Source: Bloomberg, Commerzbank

Sources
MSCI, Solactive, Euronext, S&P, Bloomberg, UN PRI, Lyxor, BNP Paribas, UBS