2 new ESG ETFs bring small- and mid-cap stocks into focus

The funds are the first ETFs to track the environmental, social and governance versions of the indexes. The DWS suite of ESG ETFs come with a tracking error of about one percentage point.

In the latest example of the asset management industry bending to the whims of the markets, DWS has added two new ESG strategies to its ETF lineup.

Xtrackers S&P MidCap 400 ESG ETF (MIDE), and Xtrackers S&P SmallCap 600 ESG ETF (SMLE) listed Wednesday applying sustainable investing screens to the popular indexes.

These are the first ETFs to track the environmental, social and governance versions of the indexes.

“At DWS, we have made ESG-centric investing integral to our value proposition for our clients and the launch of MIDE and SMLE is a logical follow-on,” said Arne Noack, DWS head of systematic investment solutions.

“We seek to provide investors with transparency around relevant ESG-metrics of a potential investment,” he added. “Investors can, for example, easily view the reduction in carbon footprint of the underlying companies, compared to a non-ESG benchmark.”

The new listings follow the Xtrackers S&P 500 ESG ETF (SNPE), which launched in June 2019 and has since grown to nearly $450 million. That fund gained 19.9% in 2020 and is up 3.4% this year through Feb. 23, which compares to the S&P 500 Index, which gained 16.3% last year and is up 3.3% so far this year.

Todd Rosenbluth, director of mutual fund and ETF research at CFRA, said the two new ESG-focused funds are well-timed to investor demand for such products.

“Demand for ESG ETFs has been increasing the last few years but the focus has primarily been on large-cap securities,” he said. “The expansion of products to mid and small caps tied to widely followed S&P benchmarks will make it easier for advisers to shift their model portfolios to an ESG approach.”

As Noack explained it, the ESG index funds, like ETFs, include fewer stocks than the non-ESG indexes that track because the ESG screens trim the bottom 25% of companies from each industry group.

The S&P 500 Index, which is made up of 505 companies, is trimmed to 296 companies when the ESG screens are applied.

The mid-cap index is trimmed from 400 names to 274, and the small-cap index is trimmed from 601 names to 407.

For that reason, Noack warns that investors should be prepared for a performance tracking error of about one percentage point.

“Investors should be mindful of the fact this universe won’t track the index perfectly,” he said. “These tracking errors are very reasonable, but if you’re super benchmark minded you will want to be looking out for this.”