Last week, Betashares launched its eighth ‘ethical’ exchange traded fund (ETF). To trade on the ASX under the ticker ERTH, the Betashares Climate Change Innovation Fund tracks the performance of an index that provides exposure to 100 of the largest global companies that are at the forefront of tackling today’s climate and environmental challenges.

I was a bit surprised to see that Zoom was its third biggest holding, with a weighting of 4.2%, not because the company is not committed to green initiatives,  but rather because its communications solution doesn’t appear to have been purposed for the task of tackling climate change. But obviously, it met the test of this index, which says that to be eligible, companies must derive 50% of their revenue from “green revenue”.

In an environment where the market for ‘ethical’ or ‘ESG’ (environmental, social and corporate governance) investment products is booming, this anecdote highlights the importance of “looking under the bonnet” before deciding where to invest. But it also raises the question about returns, and whether ESG returns stack up compared to “normal” investing.

Let’s look at the four major Australian share ESG focussed ETFs. These are: FAIR from Betashares, RARI from Russell, GRNV from VanEck and Vanguard’s VETH.

1. FAIR

FAIR, which is the BetaShares Australian Sustainability Leaders ETF, is the largest at around $852m in size. It tracks an index provided by the NASDAQ of Australian companies that have been screened to preference companies engaged in sustainable business activities and avoids companies engaged in negative ESG risks. The avoids include fossil fuels, gambling, tobacco, uranium, alcohol, junk foods, chemicals of concern, payday lending or who have a lack of gender diversity at Board level.

The index preferences “sustainability leaders” (companies that have more than 20% of their revenue coming from specified industries), are rated “A” or “B” by a trusted ethical consumer report, and are a Certified B Corporation (an ESG certification from B Lab). Companies are roughly market weighted, with a maximum weighting in the fund of 4% applied when annually re-balanced.

The “top 10 “ list of holdings is quite interesting (only CSL in the ASX “top 10” qualifies)::

1. Resmed 4.2%
2. Xero 4.1%
3. Telstra 4.0%
4. Fisher & Paykel 3.9%
5. Sonic Healthcare 3.8%
6. Brambles 3.8%
7. Goodman 3.7%
8. CSL 3.6%
9. Cochlear 3.5%
10. Suncorp Group 3.5%

By design, regional bank stocks and insurance companies are included, but major banks are excluded.

Because of the absence of the major banks and the large resource companies, recent performance for the ETF has been soft. In the 12 months to 28 February, its total return was 0.05%. In comparison, the ASX 200 Accumulation index returned 6.48%.  Over 3 years, it has done a lot better (7.28% pa vs the accumulation index of 7.39%), and over 5 years, the index return at 10.50% pa is marginally below the ASX 200 accumulation index return of 10.74% pa. Management costs are estimated to be 0.49% pa.

2. RARI

Russell Investments Australian Responsible Investment ETF (RARI) tracks the Russell Australia ESG High Dividend index. Companies are selected on the basis of demonstrating positive ESG characteristics, and negatively screened for engaging in activities that are deemed inconsistent with widely recognized responsible investment considerations. The index is also weighted to improve expected income distributions, including franking credits.

Major banks are eligible for inclusion, so RARI’s “top 10” looks more like the standard ASX “top 10”. Some resource companies (such as Fortescue) are also eligible. Its “top 10” is as follows:

1. CBA 9.1%
2. National Australia 5.3%
3. CSL 4.8%
4. ANZ 4.8%
5. Westpac 4.5%
6. Wesfarmers 4.0%
7. Telstra 3.0%
8. Macquarie 2.8%
9. Transurban 2.7%
10. Fortescue 2.3%

At $261m in size, it is quite a bit smaller than FAIR. Management fees are estimated to be 0.45%.

On the performance side, its 1 year total return is -0.8%, 3 years is 3.86% pa and 5 years is 7.93% pa (an underperformance over this period of 2.81% pa). Offsetting this is the high income component of the distribution, which is also potentially tax advantaged.

3. GRNV

The $86m VanEck Vectors MSCI Sustainable Equity ETF (GRNV) uses an index provided by world leading research agency MSCI, applying both positive and negative screens. The fund has 77 securities, and is compiled after biasing “high ESG performers”.

Interestingly, the largest sector weighting is in materials at 22.2% (above the ASX 200 weight). Its “top 10” looks like something of a cross between FAIR and RARI, with Fortescue the top holding included. ANZ Bank gets a gig, but the other majors are missing:

1. Fortescue 7.3%
2. ANZ 6.2%
3. Telstra 5.2%
4. Goodman 4.6%
5. Transurban 4.4%
6. CSL 4.4%
7. Newcrest Mining 3.6%
8. Sydney Airport 2.8%
9. Brambles 2.7%
10. Xero 2.6%

Its 1 year return (to end February) is 1.88%, 3 years is 6.42% pa.

4. VETH

Vanguard’s Ethically Conscious Australian Shares ETF (VETH) listed on the ASX in October 2020. It tracks an index from FTSE, the FTSE Australian 300 Choice Index.

It is essentially a negative screening index, excluding companies with significant business activities involving fossil fuels, nuclear power, alcohol, tobacco, gambling, weapons, adult entertainment and a conduct related screen based on severe controversies. It weights the constituents and applies rules to ensure sufficient industry diversification.

With 234 constituents (out of a total market of 300 companies), the index is probably closest to the “normal” market. Its top 10 is as follows:

1. CSL 9.1%
2. CBA 9.1%
3. Westpac 5.4%
4. National Australia 5.1%
5. ANZ 4.6%
6. Wesfarmers 4.3%
7. Fortescue 3.5%
8. Macquarie 2.9%
9. Telstra 2.8%
10. Transurban 2.7%

Missing from the “top 10” are BHP, Rio and Woolworths

According to FTSE, the index returned 5.0% for the year to end February, 7.1% pa over the last 3 years and 9.8% over the last 5 years. Compared to the Australian benchmark of the S&P/ASX 200, this is an underperformance of 1.5%, 0.3% pa and 0.9% pa respectively.

The management fee ion VETH is a very competitive 0.16% pa.

What’s the bottom line?

The negative screeners line up pretty closely. However, I am amazed by the variations caused by the positive screeners, which suggests that there is more “art” than “science” with ESG. For example, how can one fund have Fortescue as its top holding, while in another fund, there is a zero weighting?  Why is community and regional banking “fairer” than the services offered by the major banks?

There also appears to be a bit of a performance gap opening up between ESG investing and market based investing.

While there are some companies I won’t invest in, I have never put ESG considerations at the forefront of my decision making process, and on the basis of this review, I am not inclined to change. If I was going to invest with this objective, Vanguard’s VETH would be my pick.

You can also invest “ethically” overseas, which some might argue is more logical because there is a broader array of stocks available. BetaShares Global Sustainability Leaders ETHI (or its hedged currency version, HETH) and Vanguard’s Ethically Conscious International Shares Index ETF (VESG) are listed on the ASX.