Sustainable ETFs not so sustainable
‘Sustainable’ passive exchange traded funds (ETFs) are taking capital away from companies that could be having more impact on reducing the planet’s carbon footprint, according to research by French business school EDHEC.
Part of the reason why this was the case was because climate data only accounted for 12% of ETF stock weightings, while traditional market capitalisation weightings accounted for the overwhelming remainder.
Co-author of the paper, Felix Goltz, said: “If the objective is to transition to a different economy that has net zero greenhouse emissions, we know that requires a change in activity on a drastic level, and so it also requires reallocation of capital at a drastic scale”.
“If you just build portfolios that don’t look very different from standard market indices, it’s not clear how you’re going to achieve drastic change by making very small deviations.”
The research analysed European ETFs from BNP Paribas, HSBC, BlackRock and DWS Xtrackers which were based on indices marketed as ‘sustainable’ from groups such as MSCI, FTSE Russell and S&P Dow Jones.
According to the report, highly selective capital allocation which favoured climate change leaders and incentivised progress was needed to make sure companies invested in technology that allowed for minimum release of greenhouse gas.
The second factor causing this problem was that over time, these ETFs gave significant weight increases in stocks with deteriorating climate scores.
About one-third of these ‘deteriorators’ were rewarded with an increase in weight across the strategies analysed in the report.
The third mechanism which created the optical effect of improved portfolio green scores of these ETFs was their underweighting of essential sectors with high emissions, like the electricity sector.
“Since considerable investment is necessary to ensure electrification of the economy and decarbonisation of electricity, underfunding of this sector in climate-aligned benchmarks, which can correspond to a reduction in capital allocation of up to 91%, would constitute the most dangerous form of portfolio greenwashing,” Goltz said.
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