Responsible Investing

ESG ETFs: A New Toolkit for Retaining Next-Gen Assets

As perceptions flip, the question shifts from “Why Use ESG?” to “Why NOT?” 
February 2020

Mark Raes

MD, Head of Products, BMO Global Asset Management

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Amid growing awareness and demand for responsible investing solutions, Mark Raes, Head of Product, BMO Global Asset Management, discusses how Advisors can use a new suite of ESG ETFs to help retain inheritance assets destined to be passed onto the younger generation.

Evolving Attitudes on ESG – An Opportunity?

As interest in responsible investing (RI) continues to grow, particularly among Millennials, Advisors must anticipate where their clientele is headed. Nearly $1 trillion in assets is expected to be passed on in Canada during the next decade from Boomers to a younger generation who are far more attuned to environmental, social and governance (ESG) factors.1 Therefore, if you want to maintain those relationships during – and after – the wealth transfers, it’s useful to be conversant in issues that matter to them.

Case in point: recent studies show a growing number of Canadian investors consider sustainability issues when selecting their investments, a claim that’s supported by 34% growth in RI mutual funds over the past two years.2 Simultaneously, there’s a concern that ESG-focused investors are being underserved: 79% admit to wanting their Financial Advisor to inform them about RI options, yet less than a quarter have been asked if they are interested.3

The fact is we’ve arrived at an inflection point. With returns living up to the hype (as demonstrated below), the industry is waking up to long-standing myths about performance penalties associated with RI investments, and dated views are giving way to greater understanding that ESG data can lead to sound valuations, sustainable operations – and more robust returns. As perceptions flip, the question is increasingly shifting from “Why use ESG?” to “Why NOT?”

Performance of RI Funds in Canada

Performance of Responsible Investing funds in Canada as of June 30 2019

Source: BMO Global Asset Management, June 30, 2019.

BMO’s Pioneering Role within the Movement

At BMO Financial Group and BMO Global Asset Management (GAM), we are deeply committed to ESG both at the corporate level and with GAM’s 30+ year history of responsible investing through our London-based Responsible Investing team. We have a lot of history in the space – and it’s been gratifying to see investing attitudes and trends catch up during the past decade.

Historically, negative exclusions were the dominant approach, but the past decade has seen the industry evolve toward more inclusionary strategies such as ESG improvement and shareholder engagement. There’s a growing recognition that no ONE solution will fit all clients; some may opt for values-first model, while others could prefer a focus on valuations.

As such, our latest innovation in the field is a suite of eight ESG ETFs, including ETFs launched in collaboration with MSCI Inc. (MSCI), the world’s largest provider of established ESG indexes and research, to meet growing demand for RI solutions.

An All-in-One Solution – BMO Balanced ESG ETF (ZESG)

A traditional cornerstone piece in client portfolios, balanced funds have recently been adopted into an ETF structure to provide moderate long-term capital appreciation and income at an efficient total cost. Now we’ve taken it one step further, issuing Canada’s first ESG asset allocation ETF as a one-ticket solution with a 60/40 split between equity and fixed income that can be used to align socially responsible values with investments held within the portfolio.

It is a fund-of-funds that invests in equity and fixed income ETFs based on ESG ratings assigned MSCI, in keeping with our ESG Leaders approach. And although it is a universal solution that can be applied to most portfolios, it can be especially useful for servicing smaller clients with fewer investable assets, as well as those more interested in responsible themes.

Fixed Income 40%: Equity 60%:

Canadian Corporate Bonds: 10% (BMO ESG Corporate Bond Index ETF (ESGB))

Canadian Government Bonds: 26% (BMO Government Bond Index ETF (ZGB))

US Corporate Bonds: 4% (BMO ESG US Corporate Bond Hedged to CAD Index ETF (ESGF))

Canadian Equity: 15% (BMO MSCI Canada ESG Leaders Index ETF (ESGA))

U.S. Equity: 27% (BMO MSCI USA ESG Leaders Index ETF (ESGY))

International Equity: 18% (BMO MSCI EAFE ESG Leaders Index ETF (ESGE))

More Green, More Yield – BMO Global High Dividend Covered Call ETF (ZWG)

Fitting in with our wider covered call suite, BMO Global High Dividend Covered Call ETF (ZWG) offers greater appeal to income-focused investors by screening for quality dividend growers that also score well on sustainability metrics. It also collects premiums on out-of-the-money call options to simultaneously limit downside risk and boost total yield, so if a client wants broadly diversified market exposure combined with generous cash flow, that’s what this covered call strategy delivers.

The ESG integration simply ensures the underlying investments match investors’ expectations with regards to values – covering all bases. Compared with a balanced fund, which is an all-in-one solution, the focus here is on income from the equity side of the portfolio. For access to fixed income solutions that screen for the highest MSCI ESG ratings, we have BMO ESG Corporate Bond Index ETF (ESGB) and BMO ESG US Corporate Bond Hedged to CAD Index ETF (ESGF).

…there’s a spectrum of light green to dark green funds depending on how involved your clients are looking to be, which is why we provide best-in-class approaches at every level.

A Basket of Over-Achievers – BMO MSCI Global ESG Leaders Index ETF (ESGG)

BMO MSCI Global ESG Leaders Index ETF (ESGG) invests in ESG Leaders, selecting the highest rated companies in each sector and capturing 50% of the available market capitalization. This provides real differentiation from standard market funds that are “greenwashed” with ESG branding to appear aligned with socially responsible values.

To be sure, there’s a spectrum of light green to dark green funds depending on how involved your clients are looking to be, which is why we provide best-in-class approaches at every level. Portfolio managers looking to build customized portfolios can access the underlying geographies in separate funds – see below – and weigh them as needed.

Sector Representation

50% target sector representation per GICs sector and sub-region (to avoid regional and sector biases) relative to parent index.

Minimum ESG Rating

Minimum ESG rating BB

Minimum Controversy Score

Screens ongoing severe controversies

Weighting Scheme

  • Market cap weighted
  • Rebalanced quarterly with ongoing event-related maintenance

Exclusions

  • Alcohol
  • Gambling
  • Tobacco
  • Civilian firearms
  • Conventional weapons
  • Controversial weapons
  • Nuclear power

Start Client Conversations EARLY in the Process

From a tactical perspective, it’s worth being proactive about discussing responsible investing solutions. Existing clients may be aware of changes in the industry and more eager than you think to understand the options; meanwhile, newer and younger clients are likely to appreciate discussing ESG factors during the onboarding process.

Moreover, clients are beginning to see the value of spotting ESG laggards during the portfolio construction process. Consider Volkswagen: the outsized impact of the emissions scandal on both its stock price and underlying business performance not only demonstrated hidden costs in certain types of investment, but also that sustainability concerns are gaining traction among investors. 

The challenge lies in deciphering a client’s particular view of RI, because everyone has a unique set of values that map differently onto various products. In Canada, for example, investors could have important questions concerning oil and gas, or perhaps a strong view on cannabis, which informs their sector allocation preferences. From there, matching a solution to their needs is almost entirely a matter of knowing how a product works, what it screens and what it includes. So, when having a conversation with clients, the question to ask them is: How much of an ESG focus do you want?

 

To learn more about our commitment to Responsible Investing, click here, or for other ideas to enrich your practice and add value for clients, contact your BMO Regional Sales Representative.

 

Additional Insights:
Video: Morningstar, BMO’s new suite of ESG ETFs, featuring Mark Raes, February 10, 2020

 

Also in the February 2020 issue of Insights:

How to Proactively Integrate RI into Your Practice

Growing an ESG-Focused Business with Success

Disclosures

  1. Toronto-based research firm Strategic Insight projects that approximately $1 trillion in personal wealth will be transferred from one generation to the next in Canada between 2016 and 2026, with roughly 70% of that in the form of financial assets.
  2. 2019 RIA Investor Opinion Survey.
  3. Ibid.

 

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