Sustainable ESG strategies: What eco-conscious ETF investors may need to know

Venturing into sustainable funds is a growing trend for eco-conscious investors.

There are now more than 550 ESG funds, which allocate according to environmental, social and governance issues, according to Morningstar.

“We’re seeing an evolution of sustainable products right now,” said Jon Hale, global head of sustainability at Morningstar, in an interview Monday on CNBC’s “ETF Edge.”

Investors poured an annual record of $69.2 billion into ESG funds last year. Despite the continued high level of demand for the funds, Hale said that the preferences of what investors want to see from an ESG fund are “inchoate.”

“They’re not exactly incoherent,” he said, “but putting the onus back on asset managers to say, ‘here’s generally what we want, now you have to figure out the specifics of it.'”

ESG funds promote a variety of causes and initiatives. Some aim to bolster gender or racial equality, while others invest in green energy technology.

“Sustainability is complex,” Hale said. “Because it is an investment product, it needs to have competitive returns.”

To better ensure earnest performance, the ESG funds operate to include the best company in every sector, including oil and tobacco companies. As a result, environmentally friendly companies can be excluded because competitors score better on certain metrics.

Hale gave the example of Tesla, which was excluded from the S&P 500 ESG Index (SPXESUP).

“There’s all kinds of ESG issues that come into play when you’re evaluating a company,” he said. “And evaluating the potential ESG risks to that company and its stock performance.”

In the case of SPXESUP, Hale said that it was Tesla’s overall risk compared with other auto companies that excluded it.  

“But that same index isn’t really considering impact,” Hale said. “I think we need to go to a point where we’re combining [impact and risk], and there’s a more overarching analysis.”

If a stock like Tesla would be included in a portfolio because of its impact, Hale said that there’s an argument to be made for engagement — for investors to come to the table and ask a company’s plans to get to net zero, and changes in the business.

“It’s the same thing about oil companies,” Hale said. “ESG funds can make the choice. They’re not all fossil fuel-free, they don’t exclude all oil and gas companies.”

Most ESG funds will include oil companies. Occidental (OXY), for example, frequently shows up because it scores highest on certain metrics. 

“Over the last five years during this tremendous boom in ESG, generally speaking they have outperformed traditional investments.” Hale said.

Sustainable funds outperformed their peers last year, but by a narrower margin than in previous years. Slightly more than half of ESGs landed in the top half of their Morningstar category, with equity funds leading the way.