Sustainable Indexing – ETFs

Part 1 – Using Sustainable Indexing for Market-Based Socially Responsible ETFs

This article is Part 1 of a two-part series that discusses Socially Responsible Investing ETFs. This has been edited from the original article by James Osborn, Founder, Principal of Envest Asset Management, LLC in Investopedia.

Once considered a “feel good” investment strategy, socially responsible investing (“SRI”) is now at the forefront of investing. There are several methods investors use when practicing SRI. Many investors will tailor their SRI decisions to their beliefs including looking for investments that promote environmental, social, governance (“ESG”) factors, impact, or sustainability.

Socially Responsible Investing Statistics

Consider the following statistics that illustrate the growth of SRI Investing:

  • In 2016, SRI/ESG made up over 20% of the $40 trillion money management market.[i]
  • Companies that deploy ESG strategies tend to show a higher return potential and are valued at a premium when compared to their peers.[ii]
  • Companies with higher ESG ratings tend to show higher profitability and dividend yield.[iii]
  • Most corporate executives believe that a sustainable strategy is needed to remain competitive.[iv]

Ways to Practice Socially Responsible Investing

Corporations that don’t have strong corporate social responsibility (“CSR”) mandates to address ESG factors may be deemed riskier investments by investors. As a result, many corporations are responding to the demands of ESG investors.

An increase in CSR provides for an increase in SRI options so that now investors can buy stocks, bonds, or mutual funds under the SRI umbrella. Two other popular SRI methods involve the use of Exchange Traded Funds (“ETFs”). These include:

  1. Using sustainability indexing to pick ETFs that are more sustainable than their peer group
  2. Actively eliminate ETFs based on an investor’s ethics, or ethical investing.

Sustainability indexing is an effective SRI method. Using it has obvious pitfalls, like the potential for holding shares in companies that are not in-line with an investor’s ethical values. However, there are not-so-obvious benefits. When compared to their peers, some of these ETFs have lower expense ratios, higher assets under management (AUM) (i.e. liquidity), and/or higher sustainability rankings.

There are many SRI-based ETFs. While the following market-based ETFs do not have a sustainability mandate, the list below does represent highly rated sustainable indexed ETFs that focus on various market segments. Information provided is dated as of June 15th, 2018.

Market-based ETFs Using Sustainable Indexing – No ESG Mandate

 

Large Blend

Name: Schwab US Large-Cap Value ETF

Ticker: SCHV

AUM: $4.4 billion

Expense Ratio: 0.04%

Likes: Low cost; liquidity; long track record; top holdings have high sustainability mandates.

Dislikes: No sustainability mandate; controversial holdings against SRI; voting control remains with Schwab who defaults to portfolio company’s board for environmental and social proposals.

 

Large Dividend

Name: Vanguard Dividend Appreciation ETF

Ticker: VIG

AUM: $28.3 billion

Dividend Yield:1.86%

Expense Ratio: 0.08%

Likes: Low cost; liquidity; long track record; top holdings have high sustainability measures; case-by-case voting on corporate and social policy issues.

Dislikes: No sustainability mandate; controversial holdings against SRI; voting control remains with Vanguard and may default to portfolio company’s board for environmental and social proposals.

Name: Schwab US Dividend Equity ETF

Ticker: SCHD

AUM: $7.7 billion

Dividend Yield: 2.60%

Expense Ratio: 0.07%

Likes: Low cost; liquidity, long track record; top holdings have high sustainability measures.

Dislikes: No sustainability mandate; controversial SRI holdings; voting control remains with Schwab and defaults to portfolio company’s board for environmental and social proposals.

 

Mid-Cap

Name: iShares Morningstar Mid-Cap ETF

Ticker: JKG

AUM: $920.7 million

Expense Ratio: 0.15%

Likes: Higher liquidity; long track record; strong corporate governance for voting with expectations that portfolio company will report on and will deal effectively with social, ethical and environmental aspects of its business.

Dislikes: No sustainability mandate; higher cost; controversial holdings against SRI; voting control remains with Blackrock who votes based on their guidelines.

Name: Vanguard Mid-Cap Value ETF

Ticker: VOE

AUM: $9.1 billion

Expense Ratio: 0.07%

Likes: Low cost; liquidity; long track record; top holdings have high sustainability measures; case-by-case voting on corporate and social policy issues.

Dislikes: No sustainability mandate; controversial holdings against SRI; voting control remains with Vanguard and may default to portfolio company’s board for environmental and social proposals.

 

Small-Cap

Name: Vanguard Small-Cap ETF

Ticker: VB

AUM: $26.1 billion

Expense Ratio: 0.05%

Likes: Low cost; liquidity; long track record; top holdings have high sustainability measures; case-by-case voting on corporate and social policy issues.

Dislikes: No sustainability mandate; controversial holdings against SRI; voting control remains with Vanguard and may default to portfolio company’s board for environmental and social proposals.

Name: Vanguard Small-Cap Value ETF

Ticker: VBK

AUM: $8.3 billion

Expense Ratio: 0.07%

Likes: Low cost; liquidity; long track record; top holdings have high sustainability measures; case-by-case voting on corporate and social policy issues.

Dislikes: No sustainability mandate; controversial holdings against SRI; voting control remains with Vanguard and may default to portfolio company’s board for environmental and social proposals.

 

Large Foreign

Name: WisdomTree International Equity Fund

Ticker: DWM

AUM: $927.0 million

Expense Ratio: 0.48%

Likes: Higher liquidity; long track record; many holdings have high sustainability measures; third-party delegation to Mellon Capital who has sustainability and environmental proxy voting policies.

Dislikes: No sustainability mandate; higher cost; controversial holdings against SRI; voting control delegated to a Mellon Capital who may defer to portfolio company’s board in response to social proposals.

 

Emerging Markets

Name: WisdomTree Emerging Markets ex-State-Owned Enterprises Fund

Ticker: XSOE

AUM: $127.8 million

Expense Ratio: 0.32%

Likes: Many holdings have high sustainability measures; invests in emerging markets; third-party delegation to Mellon Capital who has sustainability and environmental proxy voting policies.

Dislikes: No sustainability mandate; higher cost; lower liquidity; short track record; controversial holdings against SRI; voting control delegated to a Mellon Capital who may defer to portfolio company’s board in response to social proposals.

SRI ETFs Reflect Your Values and Investment Strategy

There is currently no shortage of SRI ETFs, so the bigger issue is finding the SRI ETF funds that satisfy an investor’s ethics. Because many SRI ETFs invest in similar businesses, they are only a few differentiations like track record, fees, and shareholder advocacy voting policies. An investor should see how the characteristics of a particular fund fit into their investment strategy and portfolio, but they should also consider whether or not they align with their personal values.

Individual investors should do their own research and pay particular attention to the holdings in an SRI ETF. Many ETFs are invested in a large, diversified portfolio of companies and there isn’t always strong oversight; even though it doesn’t appear like it on the surface, it’s possible that some of the holdings might go against their personal ethics.

 

[i] US Sustainable, Responsible and Impact Investing Trends, 2016, US SIF Foundation (https://www.ussif.org/trends)

[ii] G. Giese, L. Lee, D. Melas, Z. Nagy, L. Nishikaway “Enhancing Economic Value With ESG,” MSCI Research Insight, February, 2018 (https://www.msci.com/documents/10199/48e85d65-66d4-40e7-b316-c64a95b83a04)

[iii] G. Giese, L. Lee, D. Melas, Z. Nagy, L. Nishikaway “Foundations of ESG Investing Part 1: How ESG Affects Equity Valuation, Risk and Performance,” MSCI Research Insight, November, 2017 (https://www.msci.com/documents/10199/03d6faef-2394-44e9-a119-4ca130909226)

[iv] G. Unruh, D. Kiron, N. Kruschwitz, M. Reeves, H. Rubel, and A.M. zum Felde, “Investing For a Sustainable Future,” MIT Sloan Management Review, May 2016. (https://sloanreview.mit.edu/projects/investing-for-a-sustainable-future/)

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