Transparency Could Be Better ESG Mousetrap

Exchange traded funds issuers continue developing novel ways of approaching environmental, social and governance (ESG) principles and sustainability.

Last year proves as much. Approximately 500 new ETFs came to market in 2021 – another record – and a heaping helping of those rookie funds were ESG products. Thing is with new ETFs, regardless of what the underlying investment objective is, they'd better do something to set themselves apart from the pack of established competitors.

Some ESG products are doing that, but not all the fresh concepts are catching on with advisors and clients. One that is is the the ARK Transparency ETF (CBOE:CTRU), which is two months old and has nearly $20 million in assets under management. That's a decent start for any new fund in the “ETF Terrordome.”

CTRU tracks the Transparency Index, which is a basket of the 100 most transparent companies based on the index provider's scoring methodology. All of the components trade on US exchanges and they've got an average market capitalization of $127 billion so advisors can be assured they're not putting a fund full of financially flimsy companies in front of clients.

Transparency Has Benefits

Yes, CTRU is new, but for the virtuously inclined among advisors' client bases, the fund has merit, particularly as an avenue for marrying sustainability and growth investing.

“In fact, transparency has transformed several industries meaningfully over time, with the most transparent companies often the leaders and prime beneficiaries. The internet evolved on open-source technologies and protocols that became launching pads for innovation, so much so that Apple Inc., Amazon, Facebook, and Google, now Alphabet Inc. all scaled to market capitalizations in the range of $920 billion to $2.9 trillion,” says ARK Invest client portfolio manager Thomas Hartmann-Boyce in a recent white paper.

CTRU has some commonalities with old school ESG funds, but how those similarities manifest themselves is a departure clients might enjoy. For example, CTRU's emphasis on transparency not only turns up a portfolio where constituents are less likely to be susceptible to perpetrating financial fraud and committing environmental offenses, but also one with the potential for impressive long-term returns.

Another selling point for growth-minded clients is that lack of transparency is often the enemy of innovation. That is to say companies with something to hide probably won't reward investors with high rates of growth, but due present investors with undue risk.

“History also teaches that a lack of transparency can slow the pace of innovation, with potentially disastrous consequences for economies, companies, and individuals,” adds Hartmann-Boyce. “Leveraged and opaque financial instruments like complex derivatives and non-transparent leveraged loan funds contributed to the 2008-09 global financial crisis that pushed U.S. gross domestic product (GDP) down by 4.3% from peak to trough.”

Transparency for the Long Haul

CTRU has more to like in that it significantly reduces single stock risk by not allocating more than 1.24% of its weight to any of its holdings. That's another departure from cap-weighted ESG funds, which can have substantial exposure to a small number of holdings.

Bottom line: CTRU is a new way to consider sustainability and its unique methodology could prove potent over the long-term.

“What if relative to the S&P 500 Index, the Transparency Index identified companies that committed less financial crimes and violated fewer environmental regulations? According to Transparency Invest, this could have an important impact on a company’s performance as well as on the markets themselves,” concludes Hartmann-Boyce.

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