The uptake of environmental, social and governance (ESG) ETFs over the past few years has been staggering but Vincent Deluard, director of global macro strategy at StoneX, has warned investors should not let positive momentum obscure clear red flags.

Speaking at ETF Stream’s ETF Ecosystem Unwrapped event, Deluard analysed the sudden uptake of ESG ETFs and whether it represents a bubble or a secular shift. 

“We have two new ESG ETFs being launched every day, around 500 in total and half launched within the past year, so this looks bubbly,” Deluard said.  

ESG ETFs are currently in takeover mode in Europe. According to data from Amundi, ESG ETFs in Europe accounted for 51% of total ETF flows in 2020 collecting €44.4bn assets, up from €15.9bn inflows in 2019. 

However, this has created a momentum trade, driven by the behaviour of investors, with the majority of ESG ETFs exposed to the same stocks. 

Deluard noted this was not always the case and in the past, the correlation between different ratings methodologies used to be much lower. 

More a tilt than a panacea

With the recent shift in favour of ESG index trackers – with 54% of all European Q1 inflows going into the product class – comes an array of seen and unforeseen externalities.  

Deluard said an obvious point of contention for many onlookers is having to pay higher fees for products that look very similar to cheaper, core ETFs, with ESG equivalents usually sightly overweight tech giants who already make up a sizeable chunk of traditional ETFs’ underlying indices.  

The real concern for Deluard, though, is ESG ETFs seem to prioritise the resolution of some ills at the risk of amplifying others. 

“It is about which crisis we view as most existential: climate change, equity, diversity, improving governance practices, the rise of joblessness because of automation, diverting powers away from monopolies,” he posited.  

While many make the case that big tech companies – the ESG ETF mainstays – are comparatively environmentally friendly, Deluard said he fears offering outsized support to these firms means we end up selectively ignoring the well-documented concerns raised against them.  

For instance, large tech firms should be the largest contributors to countries’ corporation tax pots, yet they are particularly adept at sidestepping this duty. The irony of this should not be overlooked – an industry reliant on the brightest minds for product innovation does not pay their fair share towards the public services (such as schools) which help to cultivate such talent. 

Furthermore, Deluard pointed to the worrying power tech monoliths wield via non-disclosure agreements with their suppliers and the end user data they own. It is also worth noting tech companies’ poor labour rights records, and more broadly, the impact ESG investment might have on blue collar jobs.   

Can ESG ETFs have an impact?

The majority of ESG ETFs tend to employ a negative screen rather than have a genuine impact which normally relies on smaller, innovative products. 

On this, Deluard said we ought to look at Silicon Valley’s approach to venture capital, where a small group of investors accept an outsized risk-return profile and then reap a reward if one in 100 companies achieves infamy.  

However, Deluard warned this model works less well within an ETF structure, where a mass of investors either end up overcrowding a single company and inflating its valuation or end up backing companies which are already mainstream.  

Speaking on investors piling into ETFs with exposure to frothy tech valuations, Deluard said: “This is growth at any cost.”  

While often inappropriate as a means of backing companies making a tangible ‘impact’ on our future, he added ESG ETFs might materially affect current dilemmas such as inflation.   

On this, he said ESG investment is contributing to a disconnect between oil prices and the pace of oil drilling, with investor fears of stranded assets meaning energy capex is far lower than it was a decade and a half ago.  

“We are moving out of the old economy too quickly before the new economy can replace it,” Deluard concluded.

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