Ethics-Based ETFs

Part 2 – Using Ethics-Based Investing for Thematic Socially Responsible ETFs

In Part 1 of a two-part series, we reviewed ETFs based on use sustainability indexing. In Part 2 of the two-part series, we take a look at Ethics-based ETFs. This has been edited from the original article by James Osborn, Founder, Principal of Envest Asset Management, LLC in Investopedia.

 

A popular and growing method to practice SRI is through ethical investing. This is the practice of an investor actively eliminating ETFs based on ethics, which is highly individualized. An investor may want to focus investments based on environment, health, human rights, etc. But be vigilant when selecting ethics-based ETFs. They tend to have higher expense ratios; however, some ETFs offer reduced fees until a specified sunset date. They can concentrate an investor’s portfolio into an industry or company. The name of an ethics-based ETF may be deceiving. For example, iShare MSCI ACWI Low Carbon Target ETF (CRBN) holds positions in Valero Energy (VLO) and Phillips 66 (PSX), and iShares MSCI USA ESG Select ETF (SUSA) holds positions in Conoco Phillips (COP) and Marathon Oil (MRO). This may give an SRI investor pause.

 

As SRI increases there are more options for providing ethics-based ETFs. Most recently BlackRock released ESML, which is a small cap, gun free SRI ETF. With short operating history, it remains to be seen how it will perform over time, but this shows that investors’ continued demand for SRI products continues to grow. Here are our top ethics-based ETFs. Figures are based on June 25, 2018.

Large Blend –Exclusions: Tobacco, Alcohol, Gambling

Name: iShares MSCI KLD 400 Social ETF

Ticker: DSI

AUM: $1.1 billion

Expense Ratio: 0.25%

Description: This ETF tracks the MSCI KLD 400 Social Index. This is composed of U.S. companies that have positive ESG programs as identified by the MSCI. MSCI tends to exclude from its index companies that are involved in tobacco, weapons, firearms, alcohol, gambling, and nuclear power.

Likes: Sustainability mandate; liquidity; long track record; distinct voting guidelines that include social or environmental responsibility, and advancement of good corporate governance.

Dislikes: Higher cost; fee waiver expires in April 2020 adding 0.25% to the current expense ratio; controversial holdings against SRI; third-party delegation of voting rights to Institutional Shareholder Services.

 

Invests in Fossil Fuel Free and Low-Carbon Companies

Name: SPDR S&P 500 Fossil Fuel Reserves Free ETF

Ticker: SPYX

AUM: $286.3 million

Expense Ratio: 0.20%

Description: SPYX tracks the performance of fossil-free companies within the S&P 500 Index. Fossil-free is defined as reserves that are recoverable sources of crude oil, natural gas, and thermal coal. The definition does not include metallurgical or coking coal.

Likes: Sustainability mandate; fossil free; strong corporate governance via discussions related to sustainability-related risks and increased direct communication between board members and shareholders.

Dislikes: Higher cost; short track record; fee waiver expires in October 2018 adding 0.05% to the current expense ratio; controversial holdings against SRI; voting control remains with State Street who votes based on their guidelines.

 

Invests in Companies With High Diversity/Inclusion

Name: SPDR SSGA Gender Diversity ETF

Ticker: SHE

AUM: $329.8 million

Expense Ratio: 0.20%

Description: SHE provides exposure to large cap U.S. companies that show greater gender diversity within senior management. SHE identifies gender diversity using State Street Global Advisors’s (“SSGA’s”) in-house gender diversity index.

Likes: Sustainability mandate; higher liquidity; diversity and inclusion; strong corporate governance via discussions related to sustainability-related risks and increased direct communication between board members and shareholders.

Dislikes: Higher cost; short track record; controversial holdings against SRI; voting control remains with State Street who votes based on their guidelines; uses in-house gender diversity index.

 

Invests in Clean Energy Companies

Name: iShares Global Clean Energy ETF

Ticker: ICLN

AUM: $172.6 million

Expense Ratio: 0.48%

Description: Fund tracks the S&P Global Clean Energy Index. It focuses on approximately 30 businesses that are considered the most liquid securities of global clean energy businesses.

Likes: Sustainability mandate; longer track record; global clean energy diversification; 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: Higher cost; lower liquidity; lacks broad diversification; voting control remains with Blackrock who votes based on their guidelines.

 

Invests in Environmentally-Conscious Companies

Name: VanEck Vectors Environmental Services ETF

Ticker: EVX

AUM: $22.6 million

Expense Ratio: 0.55%

Description: EVX tracks the NYSE Arca Environmental Services Index. Investments include businesses in the environmental services industry domestically or globally. Generally, these companies are involved in waste disposal, removal, or storage.

Likes: Sustainability mandate; longer track record; investments include waste reduction companies; case-by-case voting on corporate and social policy issues.

Dislikes: Higher cost; lower liquidity; lacks broad diversification; voting remains with VanEck who defaults its voting policy to Glass Lewis proxy guidelines.

 

Invests in Water-Conscious Companies

Name: Invesco S&P Global Water Index ETF

Ticker: CGW

AUM: $577.8 million

Expense Ratio: 0.61%

Description: The fund tracks the S&P Global Water Index. CGW is made up of U.S. and global water-related businesses that include utilities, infrastructure, and equipment.

Likes: Sustainability mandate; longer track record; higher liquidity; global water diversification; case-by-case voting on corporate and social policy issues.

Dislikes: Higher cost; lacks broad diversification; voting control remains with Invesco who votes based on their guidelines and may default to management discretion.

 

Invests in Emerging Markets

Name: iShares MSCI EM ESG Optimized ETF

Ticker: ESGE

AUM: $323.6 million

Expense Ratio: 0.25%

Description: ESGE tracks the MSCI Emerging Markets Index. This is made up of large- and mid-cap emerging market equities that have positive environmental, social and governance characteristics as identified.

Likes: Sustainability mandate; higher liquidity; emerging market investments; distinct voting guidelines that include socially or environmentally responsibility, and advancement of good corporate governance.

Dislikes: Higher cost; short track record; controversial holdings against SRI; third-party delegation of voting rights to Institutional Shareholder Services.

 

Find The Right Investment That Fits Your Needs

As there is no shortage of SRI ETFs, the bigger issue is finding appropriate SRI ETFs that meet an investor’s ethics. Many SRI ETFs invest in similar businesses making track record, fees, and shareholder advocacy voting policies the differentiating factors. An investor should see how these fit their investment style and portfolio; however, ethical investing is much more personal. An investor should pay particular attention to the holdings in an SRI ETF. On the surface, SRI ETFs shouldn’t cause an investor any ethical issues, but with an ETF invested in a large diversified portfolio of companies, an investor may find that some of the holdings may go against their personal ethics.

 

 

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/)