Vanguard Experiences Surging ETF Investments Despite Limited ESG Focus

Vanguard Group was the only major ETF provider to post an increase in European assets last year, thanks to its lower exposure to environmental, social and governance strategies, according to Morningstar Inc. Vanguard quit the world’s biggest climate-finance alliance in December.

Jose Garcia-Zarate, associate director of passive strategies at Morningstar Inc., said in an interview that the world’s second-largest asset manager is "an outlier in the European context."

A market researcher's analysis shows that Vanguard was the only exchange-traded fund provider of the industry's top five firms to see its European business grow in absolute terms last year. This is largely due to Vanguard's minimal exposure to ESG (environmental, social, and governance) factors, which underperformed mainstream investments last year.

According to Zarate, Vanguard benefited from being more exposed to fossil fuels than its peers. Morningstar estimates that the firm incorporates ESG into about 1% of its European ETFs, compared with roughly 17% of BlackRock's iShares products. Garcia-Zarate said that the fact that Vanguard's ESG business is relatively limited "helped cushion capital losses."

A spokesperson for Vanguard declined to comment.

Vanguard's European assets under management grew to €79.6 billion in the second quarter of 2020, up from €79.1 billion in the first quarter. BlackRock's iShares products saw their assets under management slip to €585.8 billion in the second quarter, down from €616.9 billion in the first quarter, according to estimates from Morningstar.

Despite challenging financial market conditions, the European ETF market showed remarkable resilience in 2022, according to Morningstar.

Garcia-Zarate said that it is unusual for asset managers operating in Europe to place as little emphasis on ESG as Vanguard does. In the US, bans against ESG investing introduced by the Republican Party have made it harder for firms to pursue the strategy, but in Europe the entire regulatory framework is designed to steer the investment industry toward greener, fairer fund allocations.

According to Garcia-Zarate, asset managers who operate in both Europe and the US generally have to tailor their marketing strategies to each region. In Europe, he says, ESG credentials are a key selling point, whereas in the US, the marketing message has to be completely different.

"Vanguard, however, has a consistent approach regardless of location," he said.

Vanguard made headlines last month when it announced it was walking out of the Net Zero Asset Managers initiative. The decision marked the biggest defection from the climate-finance alliance, which was convened by former Bank of England Governor Mark Carney in early 2021.

The investment manager said that it couldn't commit to net zero because its business model doesn't allow it to "choose the securities in a fund or dictate a portfolio company's strategy or operations." The manager noted that approximately 80% of its portfolio assets are in index-tracking funds.

Before quitting the New Zealand Asset Management Initiative (NZAMi), Vanguard had the lowest net-zero alignment of all members, the alliance said last year. An October report by environmental think tank Universal Owner found that the net-zero claims Vanguard made were difficult to verify.

Despite last year's underperformance, investment clients are still channeling money into European ESG ETFs. According to Morningstar, 65% of all flows into the region's ETFs went into ESG products in the fourth quarter. That figure was just 14% in 2019, the researcher said.

Vanguard's European presence may have grown last year, but it still pales in comparison to BlackRock. According to Morningstar, BlackRock's iShares assets under management in the region are more than seven times the size of Vanguard's ETFs.

"Investors overwhelmingly favor ESG as a long-term trend," Garcia-Zarate said. "But in 2022, when ESG did worse than mainstream assets, that helped Vanguard."

A recent Morningstar report found that Vanguard ranks lowest among asset managers in terms of ESG commitment. The firm was given a grade of "low," while BlackRock and State Street were ranked "basic."

According to Morningstar, all three firms are "constrained in their ability to lead on ESG matters, in part because most of their assets track non-ESG indexes."