Ethical investing is the current trend in investing. Investors choose investment opportunities in companies with values that align with their personal code of ethics. As a result, there has been a tremendous increase in new sustainable stock ETFs.
ETFs or exchange-traded funds are a collective basket of assets from different companies that have passed screening and qualify as ethical companies. This screening provides ethical investors with peace of mind as they can invest in stocks that meet their morals and values. Sustainable stock ETFs should focus on environmental, social, and governance issues and exclude industries like weapons, tobacco, alcohol, gambling, fossil fuels, adult entertainment, and nuclear energy.
On the other hand, the methodology to screen the companies included in an ETF should use UN labor rights standards, corruption, and environmental stewardship. It is important to pay close attention to sustainable stock ETFs because they are not equal and have different complexities, making it necessary to dig deeper to understand what every company stands for.
Choosing the right sustainable stock ETFs is important for investing ethically. Investors are always looking for a strong stock portfolio that can guarantee handsome returns alongside ethical and sustainable practices. In addition, with the increase of socially conscious investors, finding stock and funds value that address ESG issues is important. So, how do you choose the right sustainable stock ETF?
1. Asset Level
The best sustainable stock ETFs should set a minimum level of assets, with ETFs falling below the threshold having a limited degree of investor interest. A common threshold is $10 million. So, ETFs with a minimum level of assets less than $10 million do not get much interest from investors.
2. The ETFs Trading Activity
Evaluating the ETFs’ trading activity allows you to check the volume of stocks traded daily for the ETF. The volume indicates liquidity regardless of the ETF’s asset class. Sustainable stock ETFs with a higher volume of trade have higher liquidity. In addition, with ETFs, you can buy a diversified portfolio at a lower cost and accrue lower expenses than mutual funds.
It’s important to check whether the sustainable stock ETF can be traded anytime (intraday) and not just at the close of business. This makes such stocks highly liquid and less risky, especially when volatility is high. So, evaluate an ETF’s trading activity to find whether it maintains good liquidity and a reasonable expense ratio. In addition, ensure the fund has a low bid-ask spread that doesn’t increase trading costs and significantly affect returns.
3. Asset Class and Fund Management
Another important factor to consider when choosing the right sustainable stock ETFs is the fund’s underlying assets. Therefore, it is advisable to invest in an ETF with a diverse underlying asset class based on a widely followed index.
Although most ETFs don’t have active management, they should be programmed to follow a common index. This allows investors more control over when they should incur taxes.
4. Funds Ethical Focus and Metrics
As an investor, you need to decide whether the ETF focuses on environmental, social, and governance concerns and uses performance metrics in line with ESG. For instance, environmental metrics may be green revenues, fossil fuel reserves, or intensity of carbon and other greenhouse gases emission. Different metrics will highlight different attributes of companies, and choosing one metric over another may cause the composition of a fund to differ.
Sustainable stock ETFs use exclusionary screening based on their values besides ESG considerations. So, it is important to check whether the fund applies index exclusions and whether the exclusion aligns with your investment goals and beliefs. You may get a less efficient portfolio if you limit investments on a non-financial basis. This portfolio will have lower risk performance than efficient portfolios from a broader investment scope.
6. Geographical and Sector Biases
ESG scores differ across sectors and geographies. For instance, European emerging markets score poorly, yet Europe is the world leader in sustainability. In addition, some sectors like gas and oil have low ESG scores, while technology sectors score highly due to their underlying business practices. Consider such biases as they can significantly impact ETFs’ performance in the broader market.
Sustainable stock ETFs are ideal investment opportunities for ethical investors looking for low-cost stocks and increased diversification. Assess a company’s sustainability ratings by checking how it meets ESG standards to find the right sustainable stock ETF.