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ESG Investing Is Hard. Doing It via ETFs Is Harder

Passive funds with a do-good focus have become one of the hottest corners of finance.

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Illustration: Tomi Um for Bloomberg Businessweek

Over the past 15 years, two accelerating trends have reshaped finance: passive investing via funds that track broad indexes, and a focus on enterprises deemed sustainable, using so-called ESG, or environmental, social, and governance criteria. These days, the two frequently come together in the form of ESG exchange-traded funds that aim to marry sustainability considerations with the risk-balanced advantages of index investing. Last year, almost two-thirds of new ETFs had ESG ambitions, says David Hsu, an ETF specialist at Vanguard. Such funds are “by far the largest category of product being launched,” he says.

Passive ESG investing seems oxymoronic: Picking stocks—based on whatever standards—can’t be considered passive. But if done right, ESG ETFs can offer an affordable option to invest more sustainably; once the constituent companies have been selected, day-to-day management can be largely hands-off. The investments fall into three broad groups: exclusionary funds, which simply avoid certain “sin” stocks; integration funds, which use similar criteria but also take into account assessments by groups that rate companies for their adherence to ESG standards; and thematic funds, which aim to capture companies in a specific line of work, such as clean energy.