An ASX investor's guide to ESG-focused ETFs

Some tips on aligning your portfolio to your principles

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Last week, we discussed how the ethical investing trend is taking off in the ASX exchange-traded fund (ETF) sector. ESG (environmental, social and corporate governance) investing has grown in scope and scale as more and more investors want to put their money where their values lie. Of course, you can sniff out individual companies that might align with your values. But many investors are using ETFs to do this legwork for them, as well as taking advantage of the diversification and passivity that an ETF can offer.

Breaking down an ESG ETF

When it comes to ethical ESG ETFs, there are normally two classes that a fund will fall into. There are funds that follow a broad market index, such as the S&P/ASX 200 Index (ASX: XJO), but then 'filter' out any unsavoury companies from the index. And then there are those that invest in a particular ESG-aligned industry, such as renewable energy. There is a big difference between these two approaches.

Let's first look at the index funds. The BetaShares Australian Sustainability Leaders ETF (ASX: FAIR) is one such fund. This ETF tracks an index that screens ASX companies based on ESG criteria such as fossil fuel production, gambling, tobacco, alcohol, environmental destruction and animal cruelty. It holds 80 ASX shares, which includes some big names like Telstra Corporation Ltd (ASX: TLS), CSL Limited (ASX: CSL) and Xero Limited (ASX: XRO). As such, you are still getting some of the diversification benefits a simple ASX 200 index fund might provide, but without the companies that have been identified as not possessing ESG characteristics.

There are other ASX ESG ETFs that follow a similar methodology. The Vanguard Ethically Conscious Australian Shares ETF (ASX: VETH) is one. The VanEck Vectors MSCI Australian Sustainable Equity ETF (ASX: GRNV) is another. There are even funds available that take this approach and apply it to overseas shares instead of ASX companies. Such funds include the VanEck Vectors MSCI International Sustainable Equity ETF (ASX: ESGI) and the BetaShares Global Sustainability Leaders ETF (ASX: ETHI).

What about sector-specific ETFs?

That's only one side of the ASX ethical ESG ETF coin though. There are also a number of funds out there that chase specific ESG sectors. Take the ETFS Battery Tech & Lithium ETF (ASX: ACDC). This fund aims to give exposure to "the energy storage and production megatrend, including companies involved in the supply chain and production for battery technology and lithium mining."

Whilst this fund does not have a specific ESG mandate, it is still focused on an industry with 'green' credentials in aiming to reduce greenhouse gas pollution. However, a fund like this arguably provides less diversification than one of the funds named above. That's because all of the holdings in this ETF are companies that operate in a very specific sector.

The same can be said of the VanEck Vectors Global Clean Energy ETF (ASX: CLNE) or the BetaShares Climate Change Innovation ETF (ASX: ERTH).

Whilst there is nothing wrong with this approach, it's worth pointing out that there is a lot more concentration on one particular section of the ESG market. This carries its own set of risks compared to a more diversified fund.

Foolish takeaway

Ethical ESG investing looks as though it's here to stay as an investing trend. But if you are seeking out ESG funds to invest in, make sure you know what kind of exposure you are looking for. Not all ethical ETFs are equal — some of these funds might be offering a portfolio that's too concentrated for your goals, or risk profile. Just because something has 'ESG' or 'ethical' doesn't mean it's automatically a good investment.

Sebastian Bowen owns shares of Telstra Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. and Xero. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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