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Exchange-traded funds, or ETFs, may be passively managed, but that hasn’t stopped some of them from actively pushing for changes in the companies they hold. For example, the Engine No. 1 Transform 500 ETF (VOTE) uses its proxy voting power to make ESG-related changes—and it succeeded at Exxon Mobil (XOM).
Let’s look at the history of ETFs in activism, two types of activist ETFs, and where the industry may be headed looking into the future.
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Most activist investors aren’t very fond of ETFs because they promote cross-ownership. For example, an ETF may hold shares of Microsoft, Google, and Amazon—three competitors in cloud computing. As a result, ETF managers don’t have a stake in the success of any single company and tend to vote in the interest of the wider industry.
In addition to these conflicts of interest, most ETFs are interested in maximizing shareholder returns rather than achieving a social or environmental objective. As a result, large ETF managers are less likely to vote for companies to incur “optional” costs to address environmental mitigation or other ESG-related issues at the expense of profit.
Many ESG-focused ETFs have sprung up to capitalize on the growing demand for environmentally and socially friendly investments. However, these funds still take a passive approach by excluding conventional weapon makers or oil and gas companies rather than pushing for changes in companies to promote the broader social good.
Engine No. 1 Transform 500 ETF (VOTE) leverages its proxy voting power to push for changes on behalf of its holders or invest in companies with activist campaigns. At the same time, the fund tries to invest in a portfolio that’s substantially similar to the S&P 500’s risk and performance characteristics, making it a viable choice for many portfolios.
On the other hand, the LeaderShares Activist Leaders ETF (ACTV) takes a different approach to activism. The actively managed ETF focuses on equities that are already the target of shareholder activism campaigns. In particular, they invest in companies where a 5%+ owner files a Schedule 13D SEC filing indicating their intent to seek changes at a board level.
Similarly, the Global X Guru Index ETF (GURU) invests in the top holdings of hedge fund managers with a proven record of generating alpha. In many cases, these hedge funds employ activist strategies. A similar ETF that uses market hedging (rather than just long-only strategies) is the AlphaClone Alternative Alpha ETF (ALFA).
Engine No. 1’s success with its VOTE ETF suggests that there’s robust investor demand for activist ETFs focused on ESG issues. However, while ACTV, GURU, and ALFA have seen some success, investing alongside activist investors for non-ESG reasons (e.g., with a profit motive) has a mixed track record and targets a relatively niche audience.
Investors should look for more activist ETFs focused on ESG issues in the future. In the meantime, investors may want to consider mutual funds already operating under a similar model. For example, Calvert’s active equity funds and Trillium Asset Management focus on ESG research and active engagement while incorporating various asset classes.
Regardless of the fund, investors should ensure that these ETFs and mutual funds meet their other investment goals, including their risk tolerance and return expectations. It’s equally important to consider each fund’s expense ratio and liquidity to ensure that it fits within acceptable parameters for the entire investment portfolio.
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ESG issues are quickly becoming front-and-center for investors. While mutual funds have long used proxy voting to push for change, passively-managed ETFs are springing up to provide the same capabilities in an investment vehicle that offers better liquidity and potentially lower fees. These funds may help investors better achieve their ESG goals.
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