Switching to ESG ETFs: Associated Costs and Tracking Error

While ESG adoption has accelerated dramatically in recent years, there are still some investors who are hesitant to switch their holdings. The most common reasons are worries over increased tracking error from their selected benchmark and the costs of transitioning into an ESG product. In this paper, which follows from an earlier study by Flow Traders in 2021, we show that some of these fears can often be overstated.

ETF Global Capital Markets Specialist

ESG Investing: Demand is Surging

Over the last few years, demand for ESG investments has accelerated massively. While ETFs were initially slower to see this demand boom, the last three years have completely changed that. Assets in ESG ETFs in Europe now stand at $275 billion, almost double the size they were at the start of 2021 and more than four times as large as three years ago. Indeed, just in 2021, European ESG ETFs took in nearly $100 billion, accounting for almost half of total industry flows.

A range of drivers has led this surge in demand for ESG. The first is an increased scrutiny of companies’ ESG characteristics by governments and regulators. Second, the growing recognition of the climate emergency, and the immediate impact felt around the world, has raised awareness for investors and consumers of the need to act and invest sustainably. Furthermore, conversations around climate have intensified, as highlighted by the coverage of the recent COP 26 meeting, and thus we believe the demand for ESG investments is likely to continue growing during the next few years.