Many investors are starting to ask for more than just a healthy investment return. They also want to know that their money is going to companies that are doing good for the world. Here are two sustainable ETFs for your watchlist: the BetaShares Global Sustainability Leaders ETF (ASX: ETHI) and the Vanguard Ethically Conscious International Shares Index ETF (ASX: VESG).
Ethical versus sustainable
First, a quick word on terminology. The terms “ethical investing” and “sustainable investing” are often used interchangeably and neither has a totally agreed-upon definition, but to me, they have slightly different meanings.
I would say that ethical investing can be defined as limiting your investment universe to only include companies or industries that fit with your individual ethics, values and beliefs. In other words, investing only in companies that you think are doing “good” for the world, based on your definition of “good”.
Sustainable investing refers to investing with a long-term view and focusing on companies and industries that operate in a way which will remain viable for decades to come from an environmental and social point of view. In simpler terms, it’s about filtering out companies that explicitly do harm to the environment or society, or not investing in companies or industries that do “bad” things. The companies you are left with may not completely match with your values, but you feel you’ve done enough to exclude the worst offenders.
Based on the above definitions, it could be said that ethical investing is a more personal approach and everyone will have different views on what they deem to be ethical. This makes it really difficult for an ETF provider to create an “ethical” ETF, so instead, they mostly offer ETFs branded as “sustainable”.
Two of the most popular options on the ASX are ETHI and VESG. Both ETFs invest in global equities that are run through a screening process to remove companies with significant exposure to “harmful” industries. These include fossil fuels, gambling, tobacco, nuclear energy and armaments, among others.
VESG applies this screen to the FTSE Developed ex Australia Index and excludes any companies operating in these “sinful” industries. The result is that around 600 companies are removed and the underlying index becomes the FTSE Developed ex Australia Choice Index, basically a “more sustainable” version of the index.
ETHI starts with the Nasdaq Developed Markets Index and takes it a step further by applying “positive screening”, meaning after they’ve excluded the companies from the harmful industries, they start looking for the top performers in the remaining pack. ETHI only invests in companies that are among the top one-third of performers in their industry in terms of carbon efficiency or are engaged in activities to reduce carbon use by other industries.
Then, ETHI singles out companies it believes are “sustainability leaders”. These are companies that derive more than 20% of their revenue from industries like renewable energy, water efficiency, or recycling, or companies that receive an “A” or “B” grade from trusted ethical consumer reports. While not every company in the portfolio is a sustainability leader, these companies are given preference in the ETF.
What do they actually invest in?
The end result of these two screening processes is quite different. ETHI holds around 200 companies while VESG holds just over 1,500. Besides the number of holdings, there are also some differences in sector allocation.
ETHI and VESG’s three largest sectors are technology, consumer discretionary and healthcare. While both ETFs allocate around 15% each to healthcare and consumer discretionary, ETHI has a significantly higher weighting in technology – around 39% compared to 26% for VESG. This is counteracted by VESG’s higher allocation to industrials.
The end result is that ETHI might be regarded as more of a “growth” portfolio with a very high allocation to technology, while VESG is a little bit more balanced and possibly less risky.
Fees and risks
ETHI’s positive screening approach, while arguably more thorough, does come with a higher fee. ETHI charges a management fee of 0.59% per year compared to 0.18% per year for VESG. And, while ETHI’s sector allocations might seem geared towards higher growth, it is risky to put 40% of an ETF in technology shares which can be very volatile.
VESG has a relatively short track record, having only launched in September 2018, though Vanguard’s track record as an issuer would suggest that VESG is in safe hands. Another risk is that, while both ETFs invest with a global approach, around 70% of their holdings are based in the US, so they may not be quite as geographically diversified as first assumed.
ETHI or VESG?
The ETF that is right for you depends on what you are actually looking for. While both of these ETFs are certified as responsible investments by the Responsible Investment Association Australasia (RIAA), I would say that ETHI takes a more thorough approach to screening and presents a more “ethical” portfolio.
The question is whether you would be willing to pay more, and potentially take on more risk, for an ETF that is more closely aligned to your values. If you’re interested in sustainable investing, have a look at each of the issuers’ websites to see a full list of the companies ETHI and VESG invest in.
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