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Buying my first sustainable ETF

Lewis Jackson  |  17 Aug 2021Text size  Decrease  Increase  |  
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In my early 20s I spent my money on booze, holidays and repairing a second-hand motorbike. I had a savings account labelled “Investments”, but money never went anywhere except back to my spending account. In 2016, I earnt all of 9 cents in interest income.

Then I turned 28. The median Sydney house price passed $1 million and I panicked. It was time to be less grasshopper basking in an endless summer and more ant saving for the winter. I made a budget, sold the motorbike to a Russian tourist and saved up several thousand dollars to start investing.

I set myself the goal of that million-dollar house for retirement—I’d be renting till then. My age, income, and profligate youth, dictated an aggressive asset allocation model; a guide for how much to invest across the major asset classes, such as stocks, bonds, and cash.

To avoid getting overwhelmed, I started with Australian stocks.

I wanted to buy stocks via an exchange traded fund (ETF): a big basket of companies linked to an index. It was a low-cost and simple way to invest in multiple companies without having to pick them myself.

But not just any company would do. I cared about climate change and didn’t want to be part owner of a coal mine or oil rig.

Looking across the broad Australian equity ETFs that were sustainable, I narrowed the list to three:

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The BetaShares Australian Sustainability Leaders ETF (ASX: FAIR), the VanEck MSCI Australian Sustainable Equity ETF (ASX: GRNV) and Vanguard’s Ethically Conscious Australian Shares (ASX: VETH).

With my shortlist ready, I sat down one Saturday morning a few weeks ago to make my purchase. It would be more complicated than I thought.

Sustainability didn’t mean what I thought

When I started my search the word sustainability conjured images of wind farms and solar panels. What I didn’t expect to find was the world’s fourth-largest iron ore miner, Fortescue Metals Group (ASX: FMG).

I’d stumbled on the iron ore miner while using Morningstar Premium to look up the companies in each ETF. The website of each fund also had the full holdings.

VanEck’s ETF (GRNV) and Vanguard’s ETF (VETH) both held Fortescue Metals in their top ten holdings.

That Fortescue Metals Group is in the middle of a much-publicised effort to “go green ” only illustrates the difficulty of pinning down the meaning of “sustainability”.

The fund labels didn’t clarify much either, what was difference between “ethically conscious”, “sustainability leaders” and “sustainable equity”?

But beneath the synonyms were real differences in how each fund funds decided whether a company was sustainable enough to include, a process called screening.

Screening can be “negative” or “positive”. A negative screen excludes companies involved in certain activities, most commonly vice, gaming, weapons, and fossil fuels. Positive screens go further and prioritise companies that meet certain sustainability criteria.

I found details about each ETF's screens by looking through their Product Disclosure Statements, also found on the website.

For example, VETH excluded companies involved in vice, weapons, fossil fuels or that had had severe controversies, but it didn't positively screen. FAIR and GRNV went further by also positively screening for companies who scored highly on environmental, social and governance (ESG) criteria.

FAIR had a second positive screen targeting companies involved in sustainable business activities, a catch all category that included everything from renewable energy to “access to communications”.

The differences in screening go some way to explaining why the ETFs had different Morningstar Sustainability Ratings. The rating measures the ESG risk of each company in a fund—from being fined for labour abuses to getting slapped by a carbon tax—and ranks it versus similar funds.

VETH is in the top 18th percentile of funds, GRNV in the 3rd and FAIR is in the top 2nd percentile.

Differences in screening criteria had consequences. Where Commonwealth bank (ASX: CBA) was VETH’s largest holding at 10%, neither FAIR nor GRNV held it.

BetaShares says it excluded CBA over its lending to the fossil fuel industry and controversy over the banking Royal Commission.

Looking at the three funds forced me to get clearer about my ethics. Was it enough to just avoid coal miners and weapons manufacturers, or did I also want some of my dollars to flow to companies with a sustainable agenda?

I decided to take a more active approach. Of the two ETFs that did positive screening, I thought FAIR's positive screening had the most scope for including sustainable business activities.  

Sustainability isn’t risk free

But more stringent screening means fewer companies and sectors to invest in, especially in Australia, where the largest companies are miners or banks. The two sectors make up 50% of the ASX 200 index.

In excluding CBA and the high ESG risk mining and energy sectors, a fund like FAIR invests in healthcare, technology, and real estate instead. Those three sectors make up 54.5% of FAIR, more than double the 20.5% they make up in the index.

In holding FAIR, I would trade the four major banks and mining giants like Rio Tinto (ASX: RIO) for medical companies like Resmed (ASX: RMD), technology companies like Xero (ASX: XRO) and real estate developers like Mirvac (ASX: MGR).

That trade off looks painless when healthcare and technology stocks do well, but I'd feel the pain when cyclical stocks like miners and banks return to favour, says Morningstar senior manager research analyst Chris Franz.

“Sustainability screens mean your ETF is going to be different from the index it tracks,” he says.

“You’re going to be missing parts of the market and its really visible when they’re doing well and you’re not.”

And return to favour they had. The ASX 200 had a record beating year as miners and banks soared on economic recovery.

FAIR trailed the index on a 1-year basis by 10.8% and VETH was behind by 0.78% year to date, the earliest timeframe for which data was available given how new the fund was. 

Differences in screening had led to vastly different portfolios: Fewer screens meant VETH was more like the ASX 200, while FAIR’s technology and healthcare companies left it less correlated to the index, with a beta of 0.81. A beta of 1 means a perfect historical correlation with the index.

It was a dilemma. I liked the more stringent screening of FAIR but was concerned about big bets on sleep apnea devices (Resmed) and accounting software (Xero). VETH had the security of more closely tracking the index even if its negative screening felt half hearted.

In the end I compromised with an equal weighted portfolio made up of both ETFs. It let me to deviate from the index but not to too extreme a degree.

Financial due diligence still matters

Comfortable with the sustainability credentials of my choices, it was time to check returns and fees.

On a three-year basis, the oldest for which data is available, FAIR returned 10.44%, 0.93% above the index and 2.16% above the category. Data for VETH is only available since it started in October. This year it returned 13.36%, down 0.41% versus the category and 0.78% versus the index.

Returns only tell an incomplete picture and should be weighed against factors like valuation and volatility.

On the question of fees Vanguard predictably outperformed, with half the fee of the FAIR, at 0.16% to 0.39%. By comparison the SPDR ASX 200 tracker (ASX: STW) charges 0.13%.

The final step: how much to invest?

The final step was to actually make the purchase, which meant choosing a broker. I was a little nervous. A friend told me he’d faxed forms as part of his application, and I’d never used a fax machine before.

To help decide, I asked myself two questions:

  • Which broker would be the lowest cost while still providing a decent service and access to global markets?
  • How much should I invest and how often?

Brokerage fees varied depending on the size of the trade but around $10 for a $1000 trade was a rough benchmark.

I opted for SelfWealth, with its $9.50 flat fee, access to US markets and no faxes. Superhero had cheaper brokerage but was not CHESS sponsored, meaning shares were owned by a middleman. It’s a distinction that my colleague Emma Rapaport covered here.

Knowing what I would pay to trade I could calculate how much to invest. The aim was to pay less in brokerage fees each month than the average return I might expect.

I settled on $3000 increments, putting me comfortably below the 20-year average monthly return of the ASX 200. On a journalist’s salary, that meant investing each quarter.

Suddenly, it was Saturday evening and I’d spent the day in front of my computer surrounded by spreadsheets and financial tables.

ESG funds remove some of the barriers to sustainable investing by making tricky ethical decisions on behalf of investors. However, in the absence of consistent standards, the labels on sustainability funds don't tell the full story. Investors still need to think about their values and how to translate them into investments that match. Just hopefully not for a full Saturday.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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