The Better, More Rational Way to Structure an ESG ETF

How SNPE works

SNPE tracks the S&P 500 ESG Index, which begins by excluding companies involved in controversial activities such as tobacco or controversial weapons and those not adhering to the United Nations Global Compact (UNGC) principles.

However, here's where its methodology starts to diverge: the index then scores companies by their ESG score within GICS industry groups, rather than across the entire portfolio. Essentially, it selects the top-performing companies by ESG score within sectors and then weights them by float-adjusted market cap.

So, how do these ESG scores work? They measure a company’s performance on managing ESG risks and opportunities, using company disclosures, media analysis, and in-depth engagement via the S&P Global Corporate Sustainability Assessment (CSA). The scores compare a company’s performance to its industry peers, evaluated on about 35 key sustainability topics, each weighted and aggregated into a 0–100 scale.

Again, this is done within sectors on a peer-to-peer approach, allowing the fund to sift through sectors like Energy and compare companies that score higher for ESG criteria, choosing the best ones rather than blanket-eliminating an entire sector.

Why is this important? Well, this process allows SNPE to maintain ESG tilts while also staying sector neutral. In other words, SNPE’s sector exposure does not differ markedly from the S&P 500 Index. So, any excess outperformance is as a result of the ESG selection methodology within each sector.

Xtrackers S&P 500 ESG ETF versus S&P 500 Index sector weights (6/30/2024)

This is beneficial as it ensures broad diversification and avoids over or under-concentration in any specific sector, aligning more closely with the overall market performance while adhering to ESG principles.

SNPE: historical performance

As seen in the chart below, SNPE has outperformed the S&P 500 index by 1.5% annually, along with a cumulative outperformance of over 13% since inception, despite the minimal headwind of a 0.1% expense ratio, which the index does not have. This resulted in an annualized positive tracking error of approximately 1.56%, indicating outperformance.

Cumulative performance of Xtrackers S&P 500 ESG ETF and S&P 500 Index (6/30/2019 to 6/30/2024)

It's important to realize this outperformance wasn't due to taking on excessive risks. During this period, SNPE maintained an annualized volatility with a standard deviation of 18.1%, compared to 18% for the S&P 500 parent index, and a beta of 1.01.

In other words, SNPE provided more units of return for its level of risk, boasting a Sharpe ratio of 0.82 versus 0.76 for the S&P 500. Again, this is past performance, but it demonstrates that ESG investing, when done right, doesn't mean sacrificing returns.

Risk and Returns statistics for Xtrackers S&P 500 ESG ETF versus S&P 500 Index

In summary, I believe SNPE shows that an ETF adhering to best practices—avoiding blanket industry exclusions, scoring companies within industries, maintaining a sector-neutral approach, and keeping fees low (0.1% is very competitive in this space)—can potentially achieve solid performance while aiming to be ESG compliant.

And so far, investors have taken notice – the ETF has grown to over $1.3 billion in AUM as of July 31st, 2024, including inflows of $181 million throughout 2024. Thanks to its underlying large-cap stocks sourced from the S&P 500, the ETF is also very liquid with a low bid-ask spread.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.