ESTea Guest Post from SustainFi

In May 2021, activist hedge fund Engine No. 1 shot to prominence on the back of its success in winning the shareholder fight with oil giant Exxon Mobil (XOM). The fund was relatively unknown at the time. It was founded in late 2020 by Chris James, a Wall Street veteran who formerly ran Andor Capital Management and Partner Fund Management. The San Francisco-based fund started with about $250 million in assets.

Engine No. 1’s battle against Exxon has been extensively covered in the press. Despite owning 0.02% of Exxon’s stock, the hedge fund convinced larger shareholders like BlackRock to appoint three new directors to Exxon’s board. New directors will work to advance a sustainability agenda.

Following this victory, Engine No 1 launched the first activist ESG ETF to bring about transformational change at large U.S. companies. Engine No 1 Transform 500 ETF (VOTE) launched in June 2021 with over $100 million in assets, growing to over $190 million by mid-September 2021. The ETF is run by Jennifer Grancio, a founder of BlackRock’s iShares business.

VOTE is the world’s first ESG engagement ETF. Rather than excluding companies deemed controversial, VOTE will work to bring about change through:

  • Voting in favor of climate change and other ESG proposals
  • Running activist campaigns
  • Bringing other investors on board

VOTE’s stock selection is drastically different from most ESG funds that apply ESG scores from MSCI or FTSE and are generally underweight oil and gas stocks. Large ESG funds tend to be “exclusionary”: they exclude problematic companies in controversial industries instead of driving change through shareholder activism. VOTE ETF will do the opposite by buying shares in these companies and driving change from within.

It is interesting that the fund is actually passive. VOTE tracks the Morningstar U.S. Large Cap Index, investing in around 500 of the largest U.S. stocks. The ETF seeks to generate performance and advance the ESG agenda through shareholder engagement, not by owning the “greenest” stocks or excluding companies that don’t pass ESG screens.

By getting to appoint three of their nominee directors to Exxon’s Board earlier, Engine No. 1 has shown that they can bring about change at a greater scale than any actively managed ESG mutual fund has in recent years. You can call VOTE the first “passive aggressive” ETF.

In addition, VOTE is the cheapest ESG ETF we’ve been able to find. It charges only 0.05% annually, whereas over 0.15% is the norm even for the lower-cost ESG funds. Of course, by definition, VOTE’s investors can’t generate better returns than the U.S. stock market, which the fund tracks. If VOTE’s activist campaigns are successful, other large-cap U.S. stock ETFs will also benefit. Presumably, VOTE’s investors like the fund because they are supporting ESG causes, not because they can get better returns.

With under $200 million in assets, VOTE is too small by itself to make a big difference. However, Engine No. 1 successfully lobbied large investors in the past. Recall that the hedge fund held only 0.02% of Exxon’s stock, yet was able to convince fund managers with real ownership (BlackRock, Vanguard, and State Street) to vote with them.

VOTE is, therefore, a bet on whether Engine No. 1 can convince BlackRock and other prominent asset managers to continue to vote along with them. Thankfully, most large asset managers, in particular BlackRock, are actively marketing their ESG agenda. So Engine No. 1 may find it easier to get their attention than ever before.

version of this article first appeared on SustainFi. SustainFi is a personal finance and investing site that connects retail investors who want to make an impact with their money with the right products and services.