In an increasingly crowded field of exchange-traded fund (ETF) products, investors need to be able to identify which funds offer the most sustainable long-term value.
Sustainable ETFs are those that meet specific environmental, social, and governance standards regarding the management of natural resources, the treatment of employees, and accountability to shareholders.
The demand for sustainable ETFs has grown so much in recent years that there’s now a primary listing market for them.
In this article we answer the question “What are the characteristics of a sustainable ETF?” and explore how different factors might influence the sustainability of an ETF investment.
Table of Contents
What Is a Sustainable ETF?
An exchange-traded fund is a marketable security that holds assets and trades like a stock on a stock exchange. It can be thought of as a mutual fund that is traded like a stock.
That said, a sustainable ETF is a type of index fund that uses sustainable investing principles to select stocks.
Although the underlying concepts of sustainable investing have remained steady over the years, the industry has seen significant growth over the past decade. The rise in popularity of sustainable investing has largely been driven by increasing investor awareness of environmental, social and governance (ESG) issues.
How to Identify a Sustainable ETF
Investors and other stakeholders need to be able to identify sustainable ETFs. To do this, they must first understand the core characteristics of sustainable investing.
Sustainable ETFs use a combination of environmental, social, and governance (ESG) criteria to select stocks. The core characteristics of sustainable investing are as follows:
Environmental Factors in Assessing ETFs
When assessing environmental factors, investors should consider how an ETF company treats the natural resources it uses. Factors that would indicate a company is taking proper care of the environment include things like energy efficiency, recycling, and the use of sustainable agricultural practices.
For example, the price of cobalt has spiked in recent years due to the surge in demand for batteries in electric vehicles. ETFs that invest in companies extracting and refining cobalt should be a priority.
Social Factors in Assessing ETFs
Social factors focus on how an ETF company treats its employees and other stakeholders. Investors should consider things such as employee benefits, work conditions, and transparency regarding its supply chain.
Governance Factors in Assessing ETFs
Governance factors deal with how an ETF company interacts with its shareholders. Investors should consider things such as the transparency of its operations, its communication with shareholders, and its adherence to financial regulations.
For example, a fund that holds shares in a major bank will be directly affected by any regulatory or operational adjustments that bank may need to make.
Financial Factors in Assessing ETFs
The financial factors in assessing ETFs include the fund’s expense ratio, the turnover rate, and the fund’s holdings.
The first step toward sustainable ETFs is to determine how the fund will generate consistent profits and how sustainable those profits are likely to be. For example, a fund that holds a large amount of cash would be expected to generate lower profits than a fund that holds high-growth stocks with high expected returns.
The Bottom LIne
The demand for sustainable ETFs has grown so much in recent years that there’s now a primary listing market for them. For investors, it has never been more important to be able to identify which funds offer the most sustainable long-term value.
Investors should closely examine each of the four major categories outlined in this article when evaluating sustainable ETFs. A fund that is constructed in a sustainable manner from top to bottom is more likely to be a long-term winner than a fund that meets only a few of these criteria.