EFIV: Why It Should Continue To Outperform The S&P 500

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Jonathan Kitchen For some reason, Environmental, Social and Governance (ESG) Investing has been politicized, often being labelled as “woke”. In fact, ESG Investing has nothing to with some hidden anti...

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In fact, ESG Investing has nothing to with some hidden anti...</p>\n\n<a href=\"https://seekingalpha.com/article/4695320-efiv-why-it-should-continue-to-outperform-the-s-and-p-500\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"ESG","symbol_name":"FlexShares STOXX US ESG Select Index Fund","start_time":0,"source_url":"https://seekingalpha.com/article/4695320-efiv-why-it-should-continue-to-outperform-the-s-and-p-500","article_id":"2437921567","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1439964619/image_1439964619.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2437921567","pubTimestamp":1716486220,"columns":[],"sourceInfo":{"source_id":"seekingalpha_fund","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"Jonathan Kitchen For some reason, Environmental, Social and Governance  Investing has been politicized, often being labelled as “woke”. 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In fact, ESG Investing has nothing to with some hidden anti-capitalist agenda, and instead, it has everything to do with risk management, numbers, and superior returns for equity holders. In the late 1950s, it was established that smoking cigarettes caused cancer. Despite this, tobacco companies continued to market their products, often, allegedly, using unscrupulous methods. In 1998, the four largest tobacco companies in the US entered into a settlement with 52 state and territory Attorney Generals, which required them to pay a minimum of $250 billion over 25 years as compensation for costs to the states’ Medicaid programs. In the ensuing years, 41 other companies have since joined this agreement, and there have been dozens of additional class action suits made by governments in other countries, as well as cigarette smokers in the US and elsewhere. It’s been a hit to the tobacco industry that’s literally measured in the trillions of dollars. What a disaster for shareholders! In 2004, an independent Filmmaker named Morgan Spurlock made a film called Super Size Me. For one month, Spurlock ate nothing but McDonald's food, and every time he was asked, “Can I Super Size that for you sir?”, he said yes. At the end of the month, he claimed his cholesterol had increased significantly, he had experienced mood swings, sexual dysfunction, the amount of fat on his liver had increased, and his body weight had increased by 13%. Soon after, a lawsuit (which was ultimately unsuccessful) was initiated by two overweight girls, and law schools started writing papers asking the question, From Butts to Big Macs - Can The Big Tobacco Litigation And Settlement With States Attorney Generals Serve As A Model For Attacking The Fast Food Industry? Fast Food chains changed their behavior rapidly. Today, when you walk into a Fast Food restaurant, there are healthy options, every item’s calorie count is disclosed, and there are multiple signs that inform as to the recommended daily intake of calories and the dangers of obesity. None of this is woke in my view. I believe it's about protecting the bottom line and limiting downside risk, one of the benefits of ESG Investing. The SPDR S&P 500 ESG ETF (NYSEARCA:EFIV) is a $1.2 Billion ETF sponsored by State Street Global Advisors that carries a 5-Star rating from Morningstar. It tracks the S&P 500 ESG Index, which, \" ... is a broad-based, market-cap-weighted index that is designed to measure the performance of securities meeting sustainability criteria, while maintaining similar overall industry group weights as the S&P 500\". As Per Graph 1, EFIV has produced superior returns to the S&P 500 (SPX) since its inception on July 27, 2020. Graph 1 - EFIV and SNPE vs. SPY Data by YCharts SNPE, offered by Xtrackers, is virtually identical to EFIV, with the difference being that EFIV’s Expense Ratio is 0.10%, whereas SNPE’s expense ratio will increase to 0.11% on December 31, 2024, from its current discounted level of 0.10%. As it has a longer track record (June 29, 2019) I have shown SNPE's performance versus the S&P 500 in Graph 2. Graph 2 - SNPE vs. SPY Data by YCharts In the short term, all three ETFs have virtually identical performance, but over the medium to long term, the excess returns of ESG focused portfolios start to become material. As seen in Table 1, this is often achieved with a slightly lower Standard Deviation. Table 1 - Comparative Performance     EFIV SNPE SPY   YTD Total Return 11.30% 11.48% 11.28%   1 Year Total Return 28.93% 29.02% 28.77%   3 Year Total Return 39.40% 39.44% 33.85%   Expense Ratio 0.10% 0.10% 0.09%   Number of Positions 326 325 504   Top 10 Positions 39.89% 39.52% 33.42%   Standard Deviation 14.52% 14.57% 14.89%   Click to enlarge In my opinion, the sources of EFIV's outperformance are long-lasting, not transient, and I recommend it as a BUY for long term investors. I. Membership in the S&P 500 ESG Index acts as a Quality Screen A very successful and experienced portfolio manager once told me that if you open the 'fridge door and the milk smells a little off, throw it away immediately, don't wait a week until it's turned into Cottage Cheese. Sometimes it's instructive to look at other investment classes to see what's worked there. With a 10 year total return of 576%, the best performing Small Cap index is the S&P Small Cap 600 (SPSM). This compares favorably to the Russell 2000 (IWM), which has had a total return of 336% over the same period. Academic studies have shown that this outperformance is, in part, due to the S&P's quality screen which excludes corporations that aren't profitable from the index. As the authors of one study put it, \"Size Matters If You Control Your Junk \". Once a year, S&P invites various corporations to fill in one or more of 62 industry specific questionnaires that review their policies and procedures, internal goals and progress towards meeting those goals, and numerous other criteria regarding corporate governance, sustainability, climate, risk management, fraud prevention, etc. A variety of external data sets are also reviewed, and there is ongoing monitoring of these companies. In the end, an ESG Score for each company is calculated, companies with the highest scores are included in the ESG Index, and each industry group maintains a similar weighting as they do in the broader S&P 500. In other words, not every oil company is excluded from the index merely because they produce fossil fuels. Instead, oil companies such as Exxon (XOM) and Marathon Oil (MRO), that have a high proportion of independent directors on their boards, produce a barrel of oil with a lower amount of CO2 than their competitors, and have a track record of responsibly decommissioning abandoned wells no longer in production, will be included in the index, and oil companies that score poorly on these metrics will not be. S&P throws out the milk that's going bad, and investors don't even have to open the 'fridge door'. II. What do academic studies attribute the outperformance of ESG Investing to? This paper from the NYU Stern School of Business examined over 1,000 research papers that were written between 2015 and 2020. The research papers examined the relationship between ESG and financial performance going back to the start of the century. Stern classed these papers into three categories.  Research Papers that focused on corporate performance, i.e. Return on Assets, Return on Equity, and the performance of a company's or group of companies' shares. Research Papers that focused on investment performance from the perspective of an investor. These typically examined risk-adjusted turns, Sharpe Ratios, and Alpha. Separate from the 1000+ general research papers examined, the authors also examined 59 climate change specific, or low carbon specific studies that were related to financial performance.  Chart 1: Methodology   Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020 By Tensie Whelan, Ulrich Atz, Tracy Van Holt and Casey Clark, CFA (NYU Stern) The results were robust and significant with regards to ESG practices and the financial performance of individual corporations. Fifty eight percent of studies showed a positive relationship between corporate performance on metrics such as ROA, ROE and the performance of their shares, with ESG. Only 8% of studies showed a negative relationship. However, the results with regard to the performance of Investment Funds that pursued ESG and Impact Investing strategies wasn't as clear cut. Only 33% of studies showed a positive relationship between ESG Investing Strategies and investment returns, and 14% showed a negative relationship. Moreover, the overall excess risk adjusted returns that investors received were negligible. Chart 2: Summary of Results   Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020 By Tensie Whelan, Ulrich Atz, Tracy Van Holt and Casey Clark, CFA (NYU Stern) With regard to the performance of ESG focused investment funds, there are several things worth noting;  The study found that the outperformance of individual corporations for metrics such as the performance of their shares materialize in the medium to long term. \"Hang et al. (2019) undertook a meta-analysis (N=142) which found corporate investments in environmental sustainability had no effect on corporate financial performance in the short term, but had positive effects over the longer-term.\" Although many of the studies examined by Stern happened in the early part of the 2000s, it's unclear how long of a time period the various studies examined was. In other words, did a study made in 2007 examine data from 2004 - 2007, or from 1999 - 2007? The S&P 500 ESG Index came into being on April 14, 2020. There are several differences between the index and the funds that were in existence prior to this which formed the basis of the various studies. First, pre-2020 funds tended to have high fees, either due to the extra costs associated with identifying socially responsible corporations, or, because fund management companies saw this area as a field rife with profit opportunities. So, although corporations pursuing ESG practices were experiencing superior financial performance, and their shares were outperforming the market, these excess returns weren't being passed on to investors. Second, many fund managers did not have a robust process for identifying exactly what were best of breed ESG practices, nor did they monitor corporations to ensure that they kept their promises and met their stated ESG goals. Third, as per this Press Release from the SEC, there was likely a lot of alleged misselling and wild claims being made at the time. None of these issues affect the S&P 500 ESG Index, or ETFs that like EFIV that track it. Indeed, EFIV's expense ratio of 0.10% is only one basis point more than that of SPY's ratio of 0.09%. The study also found that corporations with better governance tended to perform better during a crisis, and this was especially so during the 2007 - 2009 financial crisis / credit crunch. This same downside protection was apparent in 2020, when, \" ... in the first quarter of the 2020 COVID downturn, 24 of 26 ESG index funds outperformed their conventional counterparts ...\". As this study made by Statistica states about this period, \"By the fourth quarter of 2021, the S&P 500 ESG index began to steadily outperform the S&P 500 by four points on average.\" Although many of the investment decisions had been made when the Stern study was conducted, this later outperformance was not captured by it. Although it is a relatively small sample size (59 Academic Studies), the paper also indicated that narrowly focused climate funds performed better more frequently than more general ESG funds. There are three likely explanations for this. First, it may be a fad, in which case investors should be worried about mean reversion. Second, investors may view and value these practices as a cheap form of insurance that could form the basis of a legal defense 20 years down the road. So, they pay a premium. Third, the paper found evidence that companies which make climate friendly investments assess them as positive NPV projects, similar to a homeowner installing extra insulation or double pane glass windows. Such companies tend to be more innovative, and often this can lead to commercial opportunities that they can monetize.  III. Conclusion There is a robust and extensive body of academic research that shows a statistically significant relationship between ESG practices and the operational and financial performance of individual companies, and their equity. However, in the past, elevated fees by investment managers captured these excess returns. In much the same way that it screens small cap companies for profitability before including them in the S&P 600 Small Cap Index, S&P performs a valuable function for investors by screening companies in the S&P 500 on the basis of corporate governance and sustainability practices. It does this for virtually no charge; there is only a one basis point difference between the fees of EVIV and SPY. The S&P 500 ESG Index, and ETFs such as EFIV that track it, have outperformed the broader market while exhibiting a lower standard deviation, likely due to the lower draw down such firms experience during a crisis. This is the definition of positive Alpha. The academic literature indicates that the factors which have led to this Alpha (i.e. better corporate governance, risk management and investments in technology to monitor risk, innovative strategies that reduce both CO2 and energy costs) are not random. I believe, that as they are not random, they will endure over time.  Accordingly, long term investors should view EFIV as a BUY.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2437921567"}