State Street Corp. (NYSE:STT) launched its SPDR S&P 500 Fossil Fuel Free ETF with much fanfare in December 2015, its debut timed to coincide with the Paris climate talks and its credibility burnished by support from the Natural Resources Defense Council, one of the most prominent environmental lobbying groups in the U.S.
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Despite the ETF's name, it owned stakes in, for example, Transocean Ltd. (NYSE:RIG), the offshore-drilling company implicated in the Deepwater Horizon oil spill; Southern Co. (NYSE:SO), a utility that relies on coal and natural gas for 80% of its generating capacity; and Valero Energy Corp. (NYSE:VLO), a major gasoline refiner.
As demand for do-gooder investing increases, particularly among women and millennials, fund managers are retooling their lineups to include diversified funds that appeal to a wider audience. These loosely-defined strategies offer a feel-good tilt while still preserving broad market exposure, which muddies the difference between responsible funds and their plain-vanilla peers.
The lack of industrywide definitions makes reliable statistics hard to come by. The Global Sustainable Investment Alliance estimates that assets pegged to environmental, social and governance strategies, or ESG, ballooned to a record $22.9 trillion at the start of 2016, making up 26% of professionally managed money world-wide.
Yet money managers disclose few details about how they use ESG criteria, according to a report from the alliance's U.S. organization. Some analysts include solar and wind energy funds. Others don't. Some funds adhere to 'biblical' values that critics call homophobic. And some funds, like the State Street ETF, own stock in companies that are blacklisted by competitors.
"It's a very slippery space," said Elisabeth Kashner, head of ETFs for FactSet (NYSE:FDS), a data and analytics firm. "There's no consensus on what's ultimately good or bad, nor is there consensus on how to measure it."
Last August, State Street changed the name to clarify the fund's strategy of avoiding firms with coal, gas and oil reserves. It's now called the SPDR S&P 500 Fossil Fuel Reserves Free ETF (NYSE:SPYX).
"There is no iron-clad, crystal-clear, broadly consensual, industry definition of how to invest, or not invest, in fossil fuels," said Chris McKnett, head of ESG investments at State Street, who said the change was made for the sake of "precision and clarity."
ESG investing traces its modern roots to the antiapartheid divestiture campaign of the 1980s, which prodded companies to withdraw from South Africa to protest the country's institutionalized racial segregation. After apartheid was dismantled, ethical investing focused on boycotting heavy polluters and human rights violators.
As concerns about climate change increased, investors began looking for ways to reduce the carbon footprint of their portfolios without sacrificing diversification and performance. ESG became an increasingly popular solution. Instead of using market value to determine how much to allocate each company, like most traditional indexes, the strategies weight their investments based on how a company performs on ESG metrics. Some funds go a step further, using financial criteria like revenue or dividends combined with ESG scores.
Since the start of 2016, the ETF industry has launched 26 new ESG funds, according to FactSet and XTF, two market analytics firms. Firms, including Goldman Sachs Group Inc. (NYSE:GS), State Street and OppenheimerFunds, have also published research touting the performance-enhancing benefits of ESG screening.
Some fund managers believe that ESG screening can weed out companies with simmering scandals, said Sharon French, head of beta solutions for OppenheimerFunds. She cited MSCI's July 2013 ESG downgrade of Volkswagen AG (NYSE:VLKAY) due to corporate-governance problems, more than two years before the Environmental Protection Agency announced its investigation into emissions cheating.
Such strategies preserve diversification, but can make for strange bedfellows. For example, the Columbia Sustainable Global Equity Income ETF (NYSE:ESGW) includes Valero Energy Corp. and Marathon Petroleum Corp. (NYSE:MPC) among its top 20 investments; and, at one point, the single largest holding of Oppenheimer's Global ESG Revenue ETF was Wal-Mart Stores Inc. (NYSE:WMT), a company excluded from other ESG strategies because of its history of labor problems, though that may change as the company improves its ESG performance.
"Companies are the most powerful entities in the world, and they can do harm or they can do good," said Mike Jantzi, chief executive of Sustainalytics, a company that provides ESG analysis to fund managers. "But good and bad with nothing in between wasn't useful."