Core exposure focussing on companies with improving ESG profiles
Most ESG ETFs, however, will use physical replication. For instance, we have ETFs that aim to follow MSCI indices, which are among the most widely tracked benchmarks in addition to the S&P 500. These indices also apply negative screens in order to remove a range of controversial businesses. They then weight constituents by the product of their market capitalisation and overall ESG score. What is interesting here is that they include a measure of momentum to the score, which effectively increases the weight of companies with improving ESG characteristics. Investors who believe that ESG drives the financial performance of a company could be attracted to this facet. What is also relevant is that, like the S&P 500 ESG index, back-testing suggests these MSCI ESG indices could offer similar performance to their broad non-ESG equivalents, which could make them suitable replacements for core holdings.
Fixed income is the next big area for ESG
In 2019, equity products took in around 80% of total flows into ESG ETFs, despite fixed income more generally capturing around half of all flows. One of the reasons was the limited number of ESG fixed income products on the European ETF market. We expect to see the gap narrow in 2020 as new indices are developed and new passive products are launched. We launched our first fixed income ESG ETF earlier this year. The Invesco GBP Corporate Bond ESG UCITS ETF was in fact the first GBP-denominated corporate bond ETF in Europe with ESG criteria. Similar to our equity offerings, we designed this ETF to be a core holding in investor portfolios.
In conclusion, whether you are looking for equity or fixed income funds that are going to be suitable for your clients who want to align their portfolios with their own principles, ETFs are now offering a way for you to deliver a solution with potential improvements to both costs and, dare we say, performance.
About Christopher Mellor
Head of EMEA ETF Equity & Commodity Product Management
Chris leads the EMEA ETF equity and commodity product management team at Invesco, responsible for providing support and analysis for the range of equity and commodity ETFs. Before joining Invesco he worked as an investment strategist, focusing on market timing and tactical allocation across regions, sectors and styles for Sunrise, State Street Global Markets, Credit Suisse and Societé Générale. Chris holds a Doctor of Philosophy in Inorganic Chemistry from Balliol College, Oxford. He is also a charterholder of the CFA Institute.
