The cost of switching in an ESG world

Cash is really flooding into funds focused on responsible investing. Inflows to sustainable ETFs rose 111% last week to $1.73 billion, the fifth week in a row after a slight post-holiday drop. The two largest credit ETFs pegged to environmental, social and governance goals are nearing $1 billion in assets, and BlackRock’s recent vow of climate-consciousness paid off with a $600 million debut for a new ETF. Nevertheless, by all accounts, it’s an ESG ETF boom.

But this is a small amount of money when you look at the bigger picture. Net inflows to ESG ETFs were about $8 billion in 2019. When you consider that all U.S.-listed ETFs took in $330 billion last year, it becomes clear that there’s much to be done.

It’s possible that markets will never make the changes needed to address climate change fast enough, including moving assets toward a sustainable alignment. But what if the $330 billion worth of ETF inflows last year were instead entirely invested in ESG ETFs? Would that really fix the climate crisis?

Probably not. The United Nations estimates that its 2030 Sustainable Development goals (all 17 of them) need annual commitments of $5 trillion to $7 trillion. Meanwhile, getting to net zero emissions by 2050 is estimated to be a $50 trillion proposition.

For investors, there’s admittedly a cost to switching in terms of capital gains taxes. As a result, there’s only so much money to drop into ESG investments annually. Moreover, if you look at the broader market, all impact investments combined (including private equity and venture capital) are worth only $502 billion, and just over $1 trillion worth of sustainable debt (green bonds and sustainability-linked loans) has ever been issued.

However, some investment firms may be onto something: switching the existing mandate of ETFs to be ESG-oriented without forcing investors to sell (and thus avoiding the tax bite). Between 2016 and 2018, about 25 existing funds switched their investing strategies toward sustainability, according to Morningstar. These ESG facelifts didn’t seem to bother most investors when they were alerted to the switch and given the opportunity to cash out, as most stuck with their new, greener investment.

There is a parallel in the energy markets: Global emissions from energy held steady in 2019 for the first time in three years. The fact that they didn’t grow is due to big moves from the world’s largest economies away from coal in favor of renewables and natural gas. But from another perspective, all this switching has done nothing but maintain the status quo. To make a bigger difference, companies and investors might want to think beyond switching strategies to switching the purpose of the capital they’ve already deployed.

Sustainable finance in brief

• Protesters stormed BlackRock’s Paris office Monday amid concern over the asset manager’s role in climate change. BlackRock had been reducing its stake in the largest U.S. coal miner before it made its recent pledge invest more responsibly.
• It’s the methane. Leaks of the potent greenhouse gas, usually by fossil fuel companies, are one of the worst contributors to global warming. This $1.4 trillion asset manager says it’s moving toward a zero tolerance policy as far as Big Oil is concerned.
• Financing cleaner cars is potentially one of the best uses for green bonds. Toyota Motor Credit raised $2.5 billion in the first U.S. corporate green bond deal of the year.
• Venture capital firms are increasingly adding a woman to their partnership ranks. Their next step: hiring a second woman.
• Even Carl Icahn is against the SEC’s plan to make it harder for small investors to submit shareholder proposals.
• Hedge fund managers say they’re avoiding sustainable investing. Their main reason? The data.