Clients want to align their values with their investments. That’s why ESG factors have become increasingly important to them. In fact, 85% of investors have considered ESG factors when making investment decisions, according to Gartner.

“They want to have a positive impact,” says Marcus Berry, Vice-president, ETF Specialist, Invesco Ltd. “Implementing ESG allows investors that chance to exclude certain controversial sectors from their portfolios, be that tobacco, weapons, or certain types of energy stocks.”

One solution that factors into ESG is the Invesco ESG NASDAQ 100 Index ETF (QQCE), which is part of Invesco’s innovation suite of products. It’s similar to the Nasdaq-100, which is a passive index made up of the 100 largest non-financial U.S. companies on the Nasdaq Exchange, like Apple, Microsoft, and Amazon.

The difference is, the Invesco ESG NASDAQ 100 Index ETF has an ESG overlay, which excludes any companies that go against ESG factors. For instance, companies that are involved in nuclear energy, thermal coal, or weapons could be included in the Nasdaq-100 Index, but they may be excluded from the Nasdaq-100 ESG Index.

Berry notes that another reason why investors want to include ESG factors is because they see a chance to improve performance. “ESG has the potential to improve portfolio risk and return. There’s a lot of academic research that shows that by having an ESG overlay to your investments, it not only helps reduce risk, but also helps improve performance in the long term.”

For instance, from March 31, 2016, to March 31, 2022, the Nasdaq-100 returned an accumulative 239%, whereas the Nasdaq-100 ESG Index returned 248%, according to Nasdaq internal data.

If mid-cap companies are more suited towards your clients’ goals, then consider the Invesco ESG NASDAQ Next Gen 100 Index ETF (QQJE).

“What’s really exciting about this product and index is that it provides investors with an easy, diversified way to gain access to those up-and-coming companies,” says Berry. “Since 2010, 64 constituents of this Next Gen Index have graduated into the Nasdaq-100 Index, which includes names like Tesla, Netflix, and DocuSign.”

By partnering with Nasdaq, Berry notes that Invesco is able to provide innovative solutions. “The companies that Nasdaq invests in have some of the highest research and development spend in the world. What we want to provide for clients is that low-cost broad exposure to the underlying Nasdaq benchmarks.”

Overall, Invesco’s goal is to provide clients with choice.

“There’s an increasing investor demand for ESG, and we’re seeing that being driven both bottom up by investors asking for ESG, and top down whereby there are regulatory changes happening in the industry where we believe ESG’s going to be a greater focus,” he says.

“These indexes are a great first step for clients to access ESG because they’re designed to still be that core benchmark and provide a similar risk and return profile. They’re also very low cost, with a management fee of 20 basis points. For clients owning the Nasdaq-100 Index with Invesco who want to have an ESG overlay, we can simply switch them into our ESG version.”

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There has been steady growth in ESG strategies over the last decade. In just the last year, Canadian AUM in ESG strategies have skyrocketed 153% to US$21 billion, according to Invesco data.

Advisors can no longer ignore this area, as investor demand is also increasing.

“Canadians are supporting businesses that are focused on improving in areas that are aligned to their own beliefs,” says Glen Yelton, Head of ESG Client Strategies, Invesco Ltd. “And that’s where some of our products could benefit them. For instance, Invesco’s S&P Core and Tilt ESG indexes remove or underweight holdings in common indices based on ESG scores. So there’s a level of comfort knowing that they’re not investing in companies that go against their beliefs.”

To incorporate ESG strategies into portfolios, you must first ask asset managers about their approach to ESG.

“Ask them what they don’t buy, and why,” says Yelton. “ESG is an additive and has a sustainable objective. So understanding how an investment manager thinks about elimination is important.”

And ask asset managers about their ESG thesis. “Most investment managers could quickly tell you their investment thesis about performance, like which factors lead to out- or under-performance, and how they would allocate in a bull or bear market,” he says. “They should have that same level of confidence in their approach to ESG.”

They should also be able to answer questions, including What are the impacts of my ESG allocation in those markets? If they use an exclusionary approach, resulting in a growth-heavy equity portfolio, says Yelton, can they articulate what that will mean for performance in different market scenarios?

Client conversations

Many advisors don’t discuss ESG because they don’t understand it, says Yelton. His advice? “Find something that resonates with you as an individual. It’s not about performance or fees. It should be something that reflects your values. Start with that fund. If you care about something and discuss that with clients, you’ll be better able to explain it.”

And, use neutral language. Yelton suggests using terms like “sustainable future, clean water, health, or well-being.”

Doing so allows for two things. “One, you’re avoiding traditional language that could cause confusion. Two, those broad themes allow for a broader strategy.”

Busting ESG myths

Even as ESG grows, there continues to be the myth that there’s a conflated definition.

“While there is some validity to that comment on the surface, when you actually peel back the layers, there is a consistency,” says Yelton. “If you use plain language, like health and well-being, you get to a commonality of what ESG actually does mean across multiple types of investors.”

For instance, many clients want to own individual securities they can be proud of. “They want to understand why they own them, and the context of the strategy itself, which is very simple. It removes the confusion of more politically loaded terms like net zero, climate transition, or carbon mitigation.”

Another common myth is about performance. “The performance-drag myth comes from very early ESG—actually, SRI funds. That’s over 20 years ago. In the modern state, the performance you get is dependent on the asset class, investment thesis, and allocation model. ESG doesn’t drive it. It’s the way the investment manager or index is actually constructing the portfolio.”

In the end, the key is to evaluate the asset manager when you execute your due diligence. “When you look at their materials, do you believe that they believe in what they’re doing on ESG?”

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Many investors want to incorporate environmental, social, and governance (ESG) factors into their portfolios. In fact, nearly 80% of investors recently stated that ESG factors were important to consider in their investment decision-making, according to a PwC survey.

“Clients have been asking about ESG,” says Pat Chiefalo, Senior Vice-president, Head of ETFs & Index Strategies, Invesco Canada. “But it’s still very early days for ESG investing. As clients make more solid decisions around what type of ESG products and solutions they need, we want to meet them in the market to ensure we have what they’re looking for.”

The first step is to understand the difference between ESG and non-ESG mandates overall. Take Invesco’s S&P Core and Tilt ESG indexes. Both strategies have some initial exclusions (ie., to tobacco, controversial weapons and thermal coal, to name a few), and aim to screen out the worst ESG stocks, says the company.

But they differ in that the Core Index excludes the bottom 25% of stocks, based on an ESG score, within each sector. Meanwhile, the Tilt Index does not exclude any stocks. Instead, it overweights and underweights stocks based on ESG score. In this methodology, companies with lower ESG scores are included, but at a smaller weight.

Once you understand key differences between ESG and non-ESG mandates, then you can incorporate ESG factors into the portfolio construction process. One way to do that is through ESG ETFs. These differ from traditional market cap-rated ETFs, which reflect the broad structure of a particular geography, sector or asset class, says Chiefalo.

Instead, ESG ETFs evaluate a number of ESG factors for each security and respective benchmark, he says, so that the resulting portfolio better addresses ESG risks and opportunities for that particular exposure.

Earlier this year, Invesco expanded its ESG offerings by launching eight new ESG ETFs.

“We’re offering investors choice in how they would like to express ESG in their portfolios,” says Chiefalo. “We aren’t prescribing a one-ticket solution that we believe works. We’re engaging with clients, and, as they change their views, we’re evolving our product suite.”

Evaluating ESG ETFs 

Being mindful of ESG risks, like greenwashing, is important when evaluating a basket of securities.

“We all see the headlines,” says Chiefalo. “The risks are growing, and advisors are becoming more concerned with these elements than they were a number of years ago. It’s important for us to engage with advisors to help them find ways of mitigating and managing these types of risks.”

The key, he notes, is to work with leaders in the space.

“Be careful around companies, securities, and areas of the market that have the potential to have very high ESG risks, and cause negative outcomes in portfolios. What we’re trying to do is reduce that exposure to the greatest extent possible, so that if these outcomes were to happen, we can help with that risk.”

Chiefalo adds that it’s important to ask clients about their values, and expected risk-return outcomes.

“Also, evaluate how the portfolio has changed now that you’ve embedded ESG products in it. How does that compare to when you didn’t have any products that had ESG factors within them?”

He notes that ESG factors are only going to gain traction in the coming decades.

“If we look forward, things like climate change and social justice will continue to be top of mind for investors and markets. So as clients think about having portfolios that address some of these issues, we want to continue to evolve to better incorporate these types of metrics.”