ESG-labelled exchange-traded funds (ETFs) can carry a higher exposure to deforestation-risk issuers of corporate bonds than non-ESG benchmarks, according to a new study. The Anthropocene Fixed Income Institute (AFII), which analysed the exposure of leading corporate bond ETFs to issuers substantially exposed to deforestation, said the issue may be caused by the underlying ESG indices used to inform the funds’ allocations relying on broad-based ESG ratings that “gloss over” deforestation risks. ESG ETFs have on average 5.8% exposure to issuers in AFII’s Deforestation Debt Universe, with a majority having higher exposure than a non-ESG equivalent passive ETF. ESG index construction rules do not typically include deforestation concerns, the AFII noted, often relying on limited business exclusions and ESG ratings. For the higher risk issuers, ESG ratings, which reflect a broad assessment of the issuer’s ESG performance, can be high, which can lead to substantial exposure, it added. While some fund exposure levels could be attributed to use of particular benchmarks, AFII noted that elsewhere “exposure variations do not seem to follow a discernible pattern”. For example, the State Street USD fund (SPPU) was found to have the highest overall exposure (7.2%), but its EUR fund (SSGABP) had the second lowest (6.2%). Poorer scoring ETFs had a higher exposure to the eight issuers with the highest maximum deforestation exposure, which included Johnson & Johnson, Mondelez International and General Mills. “Investors with issuer-specific deforestation concerns may need to check their ETF choices are aligned with their investment intentions, and it may be new index construction methods need to be developed,” the AFII said.
