Spring 2022

From Identifying Footprint to Measuring Impact: How to Evaluate RI/ESG Exposures

Fiduciaries have complex and often challenging considerations around Environmental, Social & Governance (ESG), Responsible Investing (RI) and investment mandates. To help ease the burden of due diligence, Mark Webster, Director, Institutional & Advisory, BMO ETFs, explores index-based approaches to RI and ESG.

Mark Webster
Director, Institutional & Advisory, Western Canada
Apr. 19, 2022

In its early incarnation, RI had a fairly narrow focus, identifying companies or industries which were deemed undesirable or unsuitable, to eliminate them from portfolios. Suitability was determined using an ethical framework, motivated by climate concerns and a collective sense of corporate social responsibility.

Over time, Socially Responsible Investing and its impact focus proved to be very difficult for institutional investors whose adherence to prescribed investment mandates posed a dilemma. As much as they may have wanted to conform, they were obliged to generate returns to meet investment objectives. As Fiduciaries, there remain some distinct legal obligations which cannot be ignored.

ESG investing emerged as way to meet investors’ intentions to cleanse capital while maintaining Fiduciary standards. The United Nations Principles for Responsible Investment identified ESG as being primarily a Fiduciary concept, and therefore a responsibility for all discretionary portfolio managers.1

Responsible Investment and ESG have different intentions and, as a result, are separate approaches for different investors. Individuals can choose a narrow, impact-focused exposure through an RI lens; institutional investors should apply an ESG lens to maintain their Fiduciary standards.2

Division of responsibilities certainly does clarify how investment advisors can approach discussions with clients, but the two different approaches have started to converge. For example, institutional investors have started to measure their impact,’ an objective implicit in Responsible Investment approaches.

Fortunately, transparent, rules-based Index ESG solutions are excellent platforms for deep due diligence. The table below outlines clear limitations and exclusions, which refine the exposure in the MSCI ESG Leaders methodology3:

Business involvement Exclusions – Refining the Exposure:

Alcohol

Producer earning 50% of revenues or over $1bln in revenues (LVMH)

Gambling

Producer earning 50% of revenues or over $1bln in revenues

Tobacco

Producer earning 50% of revenues or over $1bln in revenues

Nuclear Power

Companies with over 6,000 Mega Watts capacity or over 50% capacity from Nuclear sources / Companies involved in enriching nuclear fuel / Companies involved in uranium mining / Companies involved in nuclear plant design or construction

Conventional Weaponry

Companies earning 50% of revenues or over $3bln in revenues

Nuclear Weaponry

All companies manufacturing systems or components

Controversial Weaponry

All companies involved in manufacture of landmines, cluster bombs, uranium weapons, blinding lasers, biological or chemical weapons

Civilian Firearms

Companies earning 50% or more than $100mln in revenues

Unconventional Energy

Thermal Coal, Shale Oil, Shale Gas, Oil Sands, Coal Bed Methane & Coal Seam Gas

Conventional Energy

Arctic onshore or offshore, deep water, shallow water or on/​off shore

Source: MSCI.

These exclusions eliminate companies — not industries or sectors — which have controversial business operations which could impair capital. These companies form a subset in their respective industries, one which is below the standard set by their industry peers.

Having transparent rules allows Fiduciaries to have meaningful discussions with their clients to determine if the exclusions meet their objectives to cleanse capital.

A second step is required to analyze whether the exclusions have a material impact. Does the aggregate ESG score rise, and is the rise due to improvements in the E, the S or the G category? Is there significant carbon reduction?

The last step, important for Fiduciaries, is to measure the extent to which exclusions constrain economic opportunities. The table below tracks relative ESG ratings, ESG scores in aggregate and by component, and the reduced carbon footprint. Finally, from a portfolio construction perspective, it shows that ESG mandates can be used as core broad Beta exposures because they have achingly similar risk and return profiles.

Source: MSCI, and MSCI ESG Research, as of February 28, 2022. Fund ratings are updated monthly, based on holdings Jan 2022. Each fund or ETF scores a rating on a scale from CCC (laggard) to AAA (leader). The rating is based first on the weighted average score of the holdings of the fund or ETF. MSCI then assess ESG momentum to gain insight into the fund’s ESG track record, which is designed to indicate a fund’s exposure to holdings with a positive rating trend or worsening trend year over year. Finally, they review the ESG tail risk to understand the fund’s exposure to holdings with worst-of-class ESG Ratings of B and CCC. Please refer to ESG disclosures in disclaimer section for more information. Investment management has a strong arithmetic foundation for sound analysis. This is doubly important in RI/ESG, because it is a realm which demands incredible scrutiny, yet does not necessarily generate Alpha.

Our suite of RI and ESG ETFs can be valuable solutions for your discussions with clients, providing a Fiduciary foundation while also achieving investor objectives to measure the impact of their capital allocations.

Responsible Investment Solutions

INDEX BASED

BMO MSCI ACWI Paris Aligned Climate Equity Index ETF
ZGRN

Distribution Yield: N/A | Q
Mgmt. Fee: 0.25%
Risk Rating: Medium
BMO Clean Energy Index ETF
ZCLN

Distribution Yield: N/A | A
Mgmt. Fee: 0.35%
Risk Rating: High
ACTIVE
BMO Brookfield Global Renewables Infrastructure Fund
GRNI

Distribution Yield: N/A | Q
Mgmt. Fee: 0.25%
Risk Rating: Medium
BMO Women in Leadership Fund
WOMN

Distribution Yield: 1.3% | A
Mgmt. Fee: 0.35%
Risk Rating: Medium

ESG Investment Solutions

EQUITY
BMO MSCI Canada ESG Leaders Index ETF
ESGA

Distribution Yield:
2.8% | Q
Mgmt. Fee: 0.15%
Risk Rating: Medium
BMO MSCI USA ESG Leaders Index Fund
ESGY

Distribution Yield:
N/A | Q
Mgmt. Fee: 0.20%
Risk Rating: Medium
BMO MSCI EAFE ESG Leaders Index ETF
ESGE

Distribution Yield:
2.8% | Q
Mgmt. Fee: 0.25%
Risk Rating: Medium
BMO MSCI Global ESG Leaders Index Fund
ESGG

Distribution Yield: 1.7% | Q
Mgmt. Fee: 0.25%
Risk Rating: Medium to High
BMO MSCI China ESG Leaders Index Fund
ZCH

Distribution Yield: 1.6% | A
Mgmt. Fee: 0.60%
Risk Rating: Medium to High
BMO MSCI India ESG Leaders Index Fund
ZID

Distribution Yield: 0.1% | A
Mgmt. Fee: 0.60%
Risk Rating: Medium to High

FIXED INCOME

BMO ESG Corporate Bond Index ETF
ESGB

Duration: 6.3 Distribution Yield: 
2.8% | Q
Yield to Maturity: 3.0%
Mgmt. Fee: 0.15%
Risk Rating: Low
BMO ESG US Corporate Bond Index ETF (hedged to CAD)
ESGF

Duration: 8.1
Distribution Yield: 3.1% | Q
Yield to Maturity: 3.0%
Mgmt. Fee: 0.20%
Risk Rating: Low
BMO ESG High Yield US Corporate Bond Index ETF
ESGH

Duration: 4.1
Distribution Yield:
N/A | M
Yield to Maturity: 5.1%
Mgmt. Fee: 0.45%
Risk Rating: Low to Medium
BALANCED
BMO Balanced ESG ETF
ZESG

Distribution Yield:
2.2% | Q
Mgmt. Fee: 0.18%
Risk Rating: Low to Medium

Definitions
Annualized Distribution Yield: The most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV.
DIST YIELD = Distribution Yield. The Frequency of distribution: M=Monthly Q=Quarterly A=Annually
Duration: A measure of sensitivity of bond prices to changes in interest rates. For example, a 5 year duration means the bond will decrease in value by 5% if interest rates rise 1% and increase in value by 5% if interest rates fall 1%. Generally, the higher the duration the more volatile the bond’s price will be when interest rates change.
Risk Rating: Generally, the risk rating is based on how much the ETF’s returns have changed from year to year. It doesn’t tell you how volatile the ETF will be in the future. The rating can change over time. An ETF with a low risk rating can still lose money. For more information about the risk rating and specific risks that can affect the ETF’s returns, see the​“Risk Factors” section of the ETF’s prospectus.
YTM: Yield to Maturity (YTM) is the discount rate that equates the present value of a bond’s cash flows with its market price (including accrued interest). The measure does not include fees and expenses.
Mgmt. Fee: Management Fee (Mgmt. Fee) is the annual fee payable by the fund and/​or any underlying ETF(s) to BMO Asset Management Inc and/​or its affiliates for acting as trustee and/​or manager of the fund/ETF(s).

Please contact your BMO ETF Specialist for more information. Our Portfolio Managers are also available to help with trading insights. They can also be reached at 18777417263.



1 Principles for Responsible Investment (PRI), Fiduciary duty.

2 Randy Bauslaugh, Pension Fund Investment: Managing Environmental, Social and Governance (ESG) Factor Integration,” McCarthy Tétrault LLP, May 1, 2019.

3 The MSCI ESG Leaders methodology is used for the related BMO products and does not reflect BMO Financial Group’s own approach to exclusions.

Disclosures:

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The viewpoints expressed by the authors represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. The statistics in this update are based on information believed to be reliable but not guaranteed.

This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

Cash distributions, if any, on units of a BMO ETF (other than accumulating units or units subject to a distribution reinvestment plan) are expected to be paid primarily out of dividends or distributions, and other income or gains, received by the BMO ETF less the expenses of the BMO ETF, but may also consist of non-taxable amounts including returns of capital, which may be paid in the manager’s sole discretion. 

The BMO ETFs or securities referred to herein are not sponsored, endorsed or promoted by MSCI Inc. (“MSCI”), and MSCI bears no liability with respect to any such BMO ETFs or securities or any index on which such BMO ETFs or securities are based. The prospectus of the BMO ETFs contains a more detailed description of the limited relationship MSCI has with BMO Asset Management Inc. and any related BMO ETFs.

ESG Metrics can be used alongside other traditional financial metrics and information, and enable investors to evaluate funds on environmental, social and governance characteristics. ESG metrics are not an indication of current or future performance and do they represent the potential risk and reward profile of a fund. They are provided for transparency and for information purposes only. ESG Ratings are as of Feb 28 2022 and may vary from time to time. The fund-level ESG rating or score on which the ranking is based does not evaluate the ESG-related investment objectives of, or any ESG strategies used by, the fund and is not indicative of how well ESG factors are integrated by the fund, please review the prospectus to confirm strategies used.

Review the MSCI methodology behind the ESG ratings here: ESG Ratings and percentage of securities covered are available publicly here (https://www.msci.com/esg-fund-ratings) ; Index Carbon Footprint Metrics are available publicly here: (https://www.msci.com/index-carbon-footprint-metrics) Weighted average Scope 1, Scope 2 and Scope 3 carbon emissions intensity normalized by sales. (Unit: tons of CO2/ $ million sales) 

Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.

For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/​or elimination.

BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and a portfolio manager, and a separate legal entity from Bank of Montreal.

BMO Global Asset Management comprises BMO Asset Management Inc. and BMO Investments Inc.

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