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Weekly ETF Brief

Transition Into Broad Equities Exposure With ESG ETFs

We continue to see European investors’ interest and further investments in ESG-focused ETFs (labelled Article 8 or 9 under SFDR), often in preference to non-ESG funds. This transition is particularly apparent when investors increase their regional exposure by buying an ESG alternative to a non-ESG benchmark. 

4 min read
Senior Equity Strategist

So far this year, European-domiciled equity ESG ETFs have gathered US$4.4B, equivalent to a fifth of net inflows for equity ETFs. Following general flow trends, demand for ESG ETFs this year has been led by funds offering either global or US exposure, as seen in Figure 1. 

Europe-focused ESG ETFs, by comparison, have been quiet. However, Europe (including the UK) may be due for reassessment as investors look to diversify exposure, and become aware of the large valuation gap in the US. We believe investors who want to return to their home market may look for products that have the regional exposure and also meet investors’ ESG objectives. 

Figure 1: Equity ESG ETF Net Flows More Than 20% of Total European-listed Equity ETF Flows

A column chart showing the distribution of flows across European listed equity ETFs in the first 5 weeks of 2024.

US ESG Exposure: S&P 500 ESG Leaders Index

The S&P 500 ESG Leaders Index excludes controversial business activities and favours stocks with best-in-class ESG scoring. With similar industry group weights to the S&P 500, tracking error is kept low, with any difference in performance historically being to the ESG Leaders benefit. The index has proved popular given its broad allocation which maintains similar risk-return characteristics to its parent benchmark, the S&P 500® Index. It has had the highest return of all S&P ESG indices over the past three years. For more details, see our index guide, Why & How S&P 500 ESG Leaders Works or access the index methodology

The S&P 500 ESG Leaders Index methodology has resulted in overweight exposure to Information Technology and Consumer Discretionary, with both sectors more than 3% higher than in the parent index. With just 208 stocks in the index, there is a naturally higher weighting to the largest names, including Alphabet, Amazon, NVIDIA, Microsoft, Tesla, and Apple — six of the Magnificent Seven. These stocks have dominated the US stock market from excitement around the potential for AI adoption alongside rapid growth in cloud computing and automation. Unsurprisingly, the S&P 500 ESG Leaders Index was a strong performer last year, returning 30.4% versus 26.3% for the S&P 5001. This was achieved with relatively lower volatility and max drawdown.

Looking at ESG metrics, this index aims to cut emissions intensity by 36% versus the parent index. Achieving this with a tracking error of just 1.9 looks impressive compared to similar active ESG strategies. As revealed in the newly-launched S&P DJI SPIVA Sustainability Scorecard, the average Core ESG US Equity Large Cap strategy has a carbon intensity reduction of less than 20% and a tracking error of almost 4.5% versus benchmark2.

The SPDR® S&P® 500 ESG Leaders UCITS ETF cut its TER to just 0.03% on 1 November 2023. Since then, it has taken in US$1.2B, increasing total AUM to more than US$2B3.

European ESG Exposure: STOXX® Europe 600 SRI Index

The STOXX Europe 600 SRI Index’s methodology has product-involvement exclusionary screens, as well as filters to remove the highest-emitting companies and include those with the best ESG scores. Companies that fail the Sustainalytics Global Standards Screening assessment or are involved in controversial weapons are not eligible for selection. Additional exclusion filters screen for involvement in tobacco, alcohol, adult entertainment, gambling, weapons, thermal coal, oil & gas, and nuclear power.

These filters tend to result in underweight exposure to the Utilities, Energy, and Materials sectors, offset by overweight positions in Technology, Financials, and Health Care. Amongst the largest names excluded from the index are Nestle, Shell and LVMH, resulting in overweights to Novo Nordisk, ASML, and Roche. These overweight names help to explain outperformance last year.

In 2023, the STOXX 600 SRI Index net total returns were 18.9% versus 15.8% for the STOXX Europe 600 Index and 15.9% for MSCI Europe4. Despite including just a third of the number of companies (200 constituents versus 600), the risk-return profile of the SRI index is similar to its parent index, with little additional volatility. Back-tested figures over the past five years show correlation of 0.99 and tracking error of 3.2% between the two indices5

Amongst the ESG results, the STOXX 600 SRI Index has emissions intensity less than 20% that of the STOXX Europe 600 Index and a Sustainalytics ESG rating 7% higher6

Last month, Eurex (part of the Deutsche Borse Group) announced the launch of futures on the STOXX Europe 600 SRI. This should help investors manage portfolio flows and provide a hedging option, as well as support index liquidity.

The SPDR® STOXX Europe 600 SRI UCITS ETF was State Street Global Advisors’ first ESG ETF, launched in September 2019. As with the SPDR S&P 500 ESG Leaders UCITS ETF, it is Article 8 under SFDR, is physically replicated, and does not lend its securities.

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