Environmental, Social and Governance (ESG) criteria continue to be at the forefront of ETF issuers' minds. I've written before about funds claiming to be ESG funds that actually are ESG, and funds that are anti-ESG. This piece will take a look at the latest ESG offering from Blackrock/iShares that focuses on real estate.
The iShares Environmentally Aware Real Estate ETF (ERET) was launched last Tuesday, Nov. 15, and sports a 30-basis-point expense ratio, meaning that a shareholder with $1,000 invested over a calendar year would pay $30 in fees over that period. The fund is passively managed and tracks the FTSE EPRA Nareit Developed Green Target Index.
As with any passive ETF, the fact sheets and prospectus are good resources to get a feel for what the fund strategy is. However, if you really want to get into the weeds and learn about security selection criteria, weighting methodologies and other data-handling approaches, the best place to go is the index methodology, so let's start there.
The index
You may be familiar with the National Association of Real Estate Investment Trusts (NAREIT), but if not, it bills itself as "the worldwide representative voice for REITs and real estate companies with an interest in U.S. real estate." The group has been around since the 1960s and acts as a keeper of REIT data as well as a proponent of the real estate industry and real estate investors with regulators and legislators in Washington, D.C. The group has a longstanding relationship with index provider FTSE (Footsie) Russell in publishing a number of globally focused real estate indexes. Also included in this real estate index effort is the European Real Estate Association (EPRA).
The FTSE EPRA Nareit Developed Green Target Index uses the non-Green Target version of the index as its starting universe, namely the FTSE EPRA Nareit Developed Index. According to the Green Target methodology, analysts source data from GeoPhy to determine what I'll call the "greenness" of a company as well as to make assessments of the energy demands and carbon emissions of a company's portfolio of properties. In looking at GeoPhy it should be noted that unlike firms such as Sustainalytics, GeoPhy is not an ESG-focused data provider but a property valuation company that focuses on providing valuations for commercial and multifamily properties from what I can tell in reviewing its website.
Part of what this means is that it is not making any determinations as to the quality of a company's portfolio of properties. It is just passing on the self-reported Leadership in Energy and Environmental Design (LEED) property certifications and energy use and carbon emission figures from reporting properties.
The suitability of a real estate company is determined by FTSE and is achieved by splitting up the global bucket of potential constituents into regions and generating metrics within each region. If you can reach back to the last statistics course you took, the Z-Score metric is doing all the heavy lifting here. Another thing I noticed in the methodology is that in the event a company does not report Green Certification (Leed), it is given a Z-Score of -3. However, if LEED certification is not widely used in a region, then the company is assumed to be an "average" company and is given a Z-Score of 0. Also, companies that end up with an energy usage Z-Score greater than plus or minus 3 will have their score set at a maximum 3 (+/-), and the entire data set is re-ranked using these new limits.
Weights initially are set using market capitalization but then adjusted to reflect the various green certification, energy and carbon scores.
Wrapping it up
Regular readers know I'm sometimes tough on issuers claiming ESG bona fides. There are some things I like about this strategy, but instead of relying on the power of statistics to smooth, blend and otherwise homogenate the underlying data, I rather would have seen some bright lines when it comes to selection criteria.
For example, why not just use a LEED certification threshold that states eligible constituents must have at least 80% of their properties rated Silver or better? I have a feeling the reason why is that the resulting portfolio would end up being fairly small, which would lead to portfolio liquidity and other issues. I'm interested to see what kind of difference these additional screens will make on performance. For now, this is a watchlist item for me, but if you believe that "best efforts" ESG is good enough, then by all means work ERET into your allocation mix.
