Balancing ESG exposure and valuations

Environmental, Social, and Governance (ESG) ETF use has exploded over the last few years in Australia, with total assets under management (AUM) surpassing $1.5 billion in April 2021. While investors typically focus on ESG screens as the criteria for investment selection, in the current economic environment it is more important than ever to also consider valuations and sector exposure.

Macroeconomic shift – inflation environment

Investors that have been overweight technology/growth stocks since the Global Financial Crisis have performed well, amid a backdrop of falling interest rates and boosting valuations (Chart 1). However, in recent months, murmurs of inflation talk have dominated media headlines. Global commodity prices, most notably iron ore prices have skyrocketed, surpassing US$200 a tonne for the first time (Chart 2). Commodity prices are widely considered a leading indicator for inflation (Chart 3).

If inflation does return, this could spark a dramatic sell-off in high growth/technology assets. You can read more about the potential impact of inflation on investments here. Value stocks have outperformed growth stocks over the last six months as shown above. Traditional value sectors include financials, energy, utilities and industrials.

Looking under the hood

To illustrate the potential differences in risk and opportunity, below is a comparison of two ASX listed international ESG ETFs by valuations and sector exposure relative to the benchmark.

• ETF 1 tracks the MSCI World ex Australia ex Fossil Fuel Select SRI and Low Carbon Capped Index
• ETF 2 tracks the Nasdaq Future Global Sustainability Leaders Index

ETF 1 is overweight value sectors financials and industrials and ETF 2 is overweight technology.

ETF 1 price to earnings is the lowest and return on equity (ROE) is the highest relative to MSCI World ex Australia and ETF 2.

Four reasons to register for Livewire’s 100 Top-Rated Fund Series

Livewire’s 100 Top-Rated Fund Series goes live on 1 June 2021. Register now if you want:

• To get first access to a list of Australia’s 100 top-rated funds
• Detailed fund profile pages to help you compare performance, fees, and philosophy
• Exclusive in-depth interviews with expert researchers from Lonsec, Morningstar and Zenith.
• One-on-one videos and articles with 16 of Australia’s best fund managers