Is an "Anti-ESG" thematic ETF possible?

Constructing the Anti-ESG Index

I'm not a fund manager, so the process of filing a proper prospectus is beyond me. Quite simply, I opted for an equal-weight mixture of the top three large-cap U.S. listed companies in the tobacco, firearms, alcohol, and energy sectors, respectively. 

Note that my criteria for what constituted an "Anti-ESG" company were not really scientific or quantitative at all. It was based simply on what many existing ESG indexes exclude from consideration. The current roster is:

1. Energy: Chevron (CVX), Exxon Mobil (XOM), and Occidental Petroleum (OXY). 
2. Tobacco: Phillip Morris International (PM), British American Tobacco (BTI), and Altria Group (MO). 
3. Alcohol: Brown-Forman Corporation (BF.B), Constellation Brands (STZ), and Diageo (DEO).
4. Firearms: Ammo Inc. (POWW), Smith & Wesson Brands Inc. (SWBI), and Sturm Ruger & Company Inc. (RGR). 

I had IndexOne create an index here, which is updated in live time. Let's give it the ticker "$AESG." As of writing (August 4th, 2022), $AESG is actually up 9.75%, compared to the -13.44% loss suffered by the S&P 500 and the -16.52% loss suffered by the Vanguard ESG US Stock ETF (ESGV). To quote Borat: "great success!" 

Backtesting historical performance

Before I claimed victory, I wanted to see if this goofy rationale for constructing an index held up in the past compared to say, the S&P 500. I constructed an equal-weighted portfolio of the aforementioned stocks, with annual rebalancing and all dividends reinvested and got the following results:

So, from 2018 to the present, $AESG beat the S&P 500 in terms of CAGR, but took on far more volatility, for an overall poorer risk-adjusted return. 

Interestingly enough, $AESG strongly outperformed in 2022, perhaps pointing to the counter-cyclical nature of many of its holdings. In particular, energy stocks rallied due to inflation and elevated commodity prices, comprising much of the portfolio's sources of risk and return. 

Here's what the exposures of $AESG in terms of risk/return, market cap, geography, and sector look like. 

Contributions to risk and return had energy and firearms stocks accounting for more. We see a large overweight to large-caps, with small-caps coming in second. Most of the stocks were U.S. based, with some international. The only sectors represented were consumer defense, energy, and industrials. $AESG is not a diversified fund at all. 

A return to sensibility

In all seriousness, buying stocks according to an "Anti-ESG" theme is not a good idea, simply because it's grounded less in quantitative rigor than wishful thinking and hastily drawn inferences. This is an issue with some thematic funds today, with more and more ETFs tracking dubious, speculative themes. The point of this example isn't to discredit ESG – rather, it's to illustrate the need for caution when selecting investments. 

Investing solely based on the name of an ETF or its general objective isn't a good strategy for ensuring long-term success. Investors should carefully examine the underlying holdings of an ETF, its risk factor exposures, and the assumptions underlying the fund manager's strategy, then ask themselves if they're capable of explaining the fund to a stranger. If not, consider sticking to a simple, transparent, and straightforward index fund.