Given that the ESG scoring landscape is a mess, it’s not so easy to make an impactful decision when building your own ESG portfolio.
Although we don't swear by the following methodology, it’s the one we would use when making our own ESG investments.
You can build an ESG portfolio in 4 ways:
|Investment type||Your level of involvement||Cost level|
|Roboadvisor||Low||Mid, 0.4-0.5% per year|
|ETF||Mid||Mid, 0.4-0.6% per year|
|Mutual fund||Mid||High, 1.0-1.5% per year|
|Your own porfolio of individual stocks||High||Low, no management fee|
The most convenient way to get into ESG investing areprobably robo-advisors. We haven’t checked the ESG scoring the robos are using, so you should do your homework here. Not all the robos offer ESG portfolios, but we listed some that do:
- Interactive Advisors (Interactive Brokers)
- TD Ameritrade Essential Portfolios
ETFs are one of the most popular and cheapest ways to own a pre-built ESG portfolio. However, it’s quite difficult to see through the jungle of the different ESG scores. The most commonly used ESG ranking is provided by MSCI.
An ETF can be classified by using a scale of AAA rating to CCC rating.
When you choose an ETF, obviously go for the best rating, the AAA. But even if you do so, you will find names on the result list you would not intuitively include in your portfolio. Like the ETF which covers the full stock market of one specific country (UK, Australia, Sweden etc.) or one concentratiung on utility companies.
We’ve found 26 US domiciled ETFs with AAA rating when writing this article (based on etf.com’s database). The 5 biggest ones based on the asset size are:
- iShares PHLX Semiconductor ETF (SOXX)
- VanEck Vectors Semiconductor ETF (SMH)
- First Trust Rising Dividend Achievers ETF (RDVY)
- iShares MSCI United Kingdom ETF (EWU)
- iShares MSCI Australia ETF (EWA)
So what can you do here to have the biggest impact? We have no better solution than selecting the ones big the biggest ESG scores and go with them.
Alternatively, you can also filter out funds focusing on “clean” sectors like renewbale energy and check their MSCI ESG score. On etf.com you can also find more ESG scores concentrating on one specific aspect of the E, S and G. These are the
- Carbon intensity score
- Sustainable impact exposure score
- And the SRI screening criteria exposure score
So if you look for one specific aspect of the ESG, go for the ETFs with the highest subscore.
Basically the same applies to mutual funds as to the ETF universe. Look for the fund with the best ESG scores in general. We couldn’t find a hands-on online database for screening mutual funds based on ESG scores.
And the costs are definitely higher compared to ETFs.
The most work-intesnsive way is building your own ESG portfolio. But at least you don’t have to pay a management fee for a service provider for putting together a portfolio for you (roboadvisor, asset management company).
IMPACT App by Interactive Brokers could provide you an easy way to build your own ESG portfolio. You can use the app to select the most important impact values for you, like clean water or clean air, and you can align your portfolio with those values.
This is how we would build up our own ESG portfolio.
We would choose one of the free ESG score providers, MSCI, S&P or Sustanalytics. Let’s say we go with Sustanalytics.
Select the companies with the best ESG score at Sustanalytics and insert them into a spreadsheet.
Try to find the ESG score of these companies at MSCI and S&P as well.
Filter out the companies that have divergent ESG scores at the three providers. For example, if Sustainalytics says Apple has a high ESG score, MSCI says it has a medium one, we would filter out Apple from our potential target companies.
At the end of this practice you will have a list companies with the best ESG score at all the three service providers. By this exercise, we want ta make sure that we would invest in companies with unquestionable ESG scores.
We would build our portfolio from the list of remaining companies based on some other factors, such as sector preference and value factors. Don’t forget about diversification when building your own portfolio. You should have at least 20 companies in your portfolio to eliminate the most market risk, as diversification starts to have some effect around 20 companies.
This is a theoretical framework, we didn’t try it, but based on our ESG research it seems logical. Since it’s a theoretical methodology, please use it with a pinch of salt and let us know if you have any thoughts.