SEC’s new ESG rules: ‘The name doesn’t tell you the whole story,’ researcher explains

VettaFi Head of Research Todd Rosenbluth joins Yahoo Finance Live to discuss ESG funds, new SEC rulings, Tesla being dropped from the S&P 500 ESG index, and the outlook for investors.

Video transcript

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JULIE HYMAN: Securities and Exchange Commission regulators have proposed new disclosure and naming requirements for ESG, or Environmental, Social, and Governance Funds this week. The commission voted Wednesday on the proposals aimed at giving investors more information about those ETFs, as well as require that at least 80% of their holdings adhere to those labels.

Joining us now to help break down these changes is VettaFi head of research, Todd Rosenbluth. VettaFi-- by the way, the artist formerly known as ETF Trends, for those who are watch the ETF space. Todd, it's good to see you. Thanks for being here.

Man, there's so much confusion about this topic, isn't there, for investors of all stripes. How does this ETF differ from that ETF? What does ESG mean? What definition is this one using versus that one? How should people be thinking about this?

TODD ROSENBLUTH: Well, the beauty of the ETF structure is you can look inside of the portfolio and understand what you're getting, understand what it owns, and also understand what it doesn't own in relation to a broader index. And as you mentioned, we at VettaFi are focusing on this trend about ESG and making sure investors have the tools they need to understand this, because the name, which is what the SEC is focusing on, doesn't tell you the whole story. The underlying holdings do. You have to dig inside the portfolio and understand the rules and understand what is and is not inside various ESG products.

JULIE HYMAN: And does this new SEC ruling about having more rules around these disclosures, is that going to help?

TODD ROSENBLUTH: Well, it can't hurt right now, because there's a lot of confusion going on in the industry. People don't fully understand the environmental, social, and governance practices. Many people think of ESG as just the environmental, that E pillar. And so I know we're going to get into it, but about Tesla and whether it is or is not included, but people think of Tesla as an environmentally friendly company. But it isn't necessarily, according to some of the index providers, strong on that social or governance practice.

So we've actually, when we were talking with advisors this week at VettaFi, we heard that people are looking to have a cleaner part of their portfolio. They think of ESG as being a way to solve that problem. In fact, it's only solving part of that problem.

JARED BLIKRE: Well, and here's a conundrum I think about. Energy, the best performing sector of the year, up something like 45%, 50%. Not a lot of those names are ESG friendly. I recognize I'm focusing on the E. But if an investor wants to be invested in the energy sector, what kinds of companies or exposure through ETFs would they be able to get?

TODD ROSENBLUTH: Well, you're right. So it matters what kind of ETF we're talking about. So an ETF like EFIV, which is the SPDR S&P ESG ETF, or EF-- or, sorry, SNPE, which is a DWS Xtracker product that's tracking the same index, it has companies within the energy sector. It's intended to be broadly diversified across all of the sectors.

So you can look at some of those environmentally, socially strong or governance companies that fit into that portfolio and you'd be able to understand what you have and what you don't have. If you're looking to exclude energy, there are ETFs that are focused on that, that are fossil fuel reserve free. State Street also has one of those products. But the ESG lineup tends to have some exposure to energy companies if they're broad in nature. And that's in part of what the appeal has been. These ETFs tend to track the broader market because they're exposed to all the sectors within the broader market.

JULIE HYMAN: I mean, at the same time, you can see Musk's point, right, when he's looking at these criteria and whether they are evenly applied. I think that's what he and probably some investors struggle with. I mean, if you look at any company, and this is not to say that the labor practices at Tesla are great. I'm not going to weigh in on that.

But you can probably look at any company and find-- no company is going to be perfect on ESG. It's going to be very difficult to find that. So I just wonder how investors are thinking about this as they look at all this stuff. Or they just taking the definitions and what goes into them at face value?

TODD ROSENBLUTH: So I think it matters how much your priorities are for ESG. So there are two ETFs or two very popular ETFs from iShares that track MSCI benchmarks. ESGU is one of those. And then USXF is the second one.

USXF is more concentrated in companies that are the relative superstars within the ESG area as opposed to ESGU, which gives you some exposure to the companies that are relatively OK within the ESG. And it's going to kick out companies that are the worst offenders within the ESG realm within each of their respective parts of the marketplace. So you have to make sure you understand what you're getting.

We're showing USXF on the screen here. It doesn't own Apple. So it's not just Tesla that's being excluded from some of these index-based ESG ETFs. So whether or not that's a good or bad thing matters to the end investor. They need to make an informed decision. And that's something that when we wrote about this earlier this week on VettaFi's platform, we compared USXF and ESGU.

JULIE HYMAN: And finally, Todd, I want to ask how these funds are doing in terms of flows, right? They seem to have really caught on over the past few years. Certainly there are the big houses, like BlackRock, that are really pushing this stuff. Is there uptake among investors?

TODD ROSENBLUTH: So it's coming off of a very small base. We continue to see that there's been demand globally for ESG products. It has slowed a bit this year. It's a down market. So we haven't seen investor enthusiasm for putting new money to work.

Some of the assets that, asset growth that we're showing on the screen here is a result of the market strength that we saw in 2021. But thus far in 2022, because the stock market has been down, the average ESG ETF has been down. People are a little bit more hesitant to put as much new money to work. We're seeing investors focus on the broader core products than the more ESG-oriented ETFs.

JARED BLIKRE: Well, we've got to leave it there, but always appreciate your insights, Todd Rosenbluth of VettaFi.