The costs of switching core ETF holdings to ESG along with excess tracking error considerations are two crucial metrics for investors, according to research conducted by Flow Traders.

The research, which analysed 73 of the most traded exchange-traded products (ETPs) in the ESG space, found ESG ETFs with exposure to European equities have higher switching costs than other developed markets.

When switching from benchmarks such as the Euro Stoxx 50 and MSCI Europe, investors are subject to Financial Transaction Taxes which translate into more expense creation costs and in turn, higher switch costs for investors, the market maker explained.

While these switching costs for European benchmarks are approximately between 12 and 26 basis points (bps), the Japanese and US markets are far cheaper with the switch to ESG ETFs costing under five bps.

Meanwhile, switching costs for global ESG ETFs average around 13 bps and emerging markets unsurprisingly jumped higher to 35 bps.

“When considering a switch into the ESG variant of a core exposure, both switching costs and additional tracking error vs the original benchmark are of particular consideration,” the report said.

“Particularly for [global and emerging markets], but also for European-oriented products, the ability of market makers to hold inventory and use this for facilitating switch trades plays an important role. It enables investors to save on cost and therefore execute these transactions at a fraction of the original spread.”

ESG ETFs are increasingly viewed as core holdings in investor portfolios. According to a survey of professionally European investors conducted by ETF Stream and Amundi as part of an investigation into the rise of ESG ETFs, some 67% said they consider ESG a core investment.

“One of the most frequently asked questions from our counterparties relates to the costs of switching existing core exposures into the corresponding ESG or SRI version,” Flow Traders added.

The move has been enabled by ETF issuers which have launched a string of ESG versions of traditional indices such as the S&P 500 or Euro Stoxx 50. For example, there are now five ETFs in Europe that offer exposure to a version of the S&P 500 ESG index, the largest being the $1.5bn UBS S&P 500 ESG UCITS ETF (5ESG).

There remain questions around the costs involved in trading ESG ETFs, however, Will Askew, senior trader at Nutmeg, explained the ESG ETF space has developed rapidly over the past few years.

“In the specific case of ESG-focused ETFs, there were challenges in the early stages,” Askew continued. “It is perhaps more telling that given the comparatively youthful nature of the sector, just how quickly the spreads and quotes have become significantly more competitive – a strong testament to the popularity and speed of adoption across the sector.”

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