Companies with less reporting history on their carbon footprint get penalized on a tiered basis; the idea being they haven’t been as upfront on this issue. That means a company that has reported its emissions two or three times in the past five years will get penalized 10% on their score while a company that reported just once in five years gets docked with a 15% penalty.
“If a company reports nothing and we have to substitute in the industry-level estimate for it, we’ll consider them an average player in their industry and we penalize them 25%,” Waldrep said, adding they prefer to error on the side of caution with the fund’s portfolio holdings and strive to hold companies actively minimizing their carbon footprint.
The end result, according to TruShares, is that the ECOZ fund’s weighted average carbon intensity as of year-end 2020 was 27.56 versus 156.42 for the S&P 500.
The fund does pay attention to the social and governance principles as well, and its two-step investment process starts by screening companies against traditional aspects of ESG best practices ranging from their promotion of leadership diversity to implementing minority hiring practices, along with carbon emissions reductions.
“We emphasize different factors based on the sector they’re in because there is no simple one-stop shop for these issues,” Waldrep said. "We want to evaluate companies that are preparing for what’s to be expected of them from consumers, investors and governments in the future. That means we want companies that are preparing for the economy of tomorrow and are aware of the real risks for them going forward.”
That produces an investable universe of roughly 100 to 150 companies, and these are assigned an ESG rating. The second phase of the process involves additional analysis to ascertain a company’s intrinsic value and comparing that to its share price to determine its relative value. Those companies making the cut (the portfolio currently has about 70 positions) are ranked based on their ESG rating and relative value.
The fund’s recent top holdings included electric vehicle maker Tesla and solar energy company Enphase Energy. Other top holdings included stalwart tech names Microsoft, Alphabet, Amazon.com and Apple. Its expense ratio is 0.58%.
“ESG is becoming more important to investors and regulators and governments, so companies are improving," Waldrep said. “You can say it’s greenwashing, but the reality is companies like Google, Amazon, Facebook and Apple have been making big green initiatives because it makes sense for them to do it because they’re getting ready for the regulations of tomorrow.”
Active Or Passive
Other funds have also developed processes to help quantify how well companies are meeting ESG standards and making a positive societal impact.
The Humankind US Stock ETF (HKND), for example, takes a passive approach to quantifying ESG by tracking a self-created index incorporating public disclosures from individual companies and tapping into data sources from various third-party research houses, scientific and academic papers, government agencies and NGOs. Companies are ranked based on a quantitative analysis of their positive and negative contributions to society as measured by their impact on investors, consumers, employees and society. In total, this is described as a company’s “humankind” value.
The long list of factors considered when determining these scores range from greenhouse gas emissions and slave labor to plastic pollution and predatory lending.
Next, the index methodology applies a proprietary algorithm that adjusts each company’s humankind value on the basis of its supply chain relationships, which is gleaned from company-to-company links disclosed in company filings, as well as by analyzing industry classification frameworks that determine the supply chain links between industries.
The end result produces a score that is meant to represent a company’s true social and economic value to humanity. Companies within the index are weighted by their humankind value score.
This fund debuted in February and has an expense ratio of 0.11%.
When it comes to quantifying ESG, the two funds mentioned in this article represent the “active vs. passive” debate that permeates the ETF industry. So far, the TrueShares ESG Active Opportunities ETF has turned in impressive results but has only a little less than $9 million in assets after nearly 13 months of trading.
The Humankind US Stock ETF, which is just a month old, already has $28 million in assets.
Then again, judging ESG funds by asset levels is a shallow measuring stick that matters more to fund sponsors than to investors, who are more concerned with share price performance and whether ESG funds are actually making a difference on environmental, social and governance issues.