2017: Year Of Socially Responsible ETFs

December 15, 2016

Every year, Matt Hougan and I give the keynote address at InsideETFs. Sometime about a month before the conference (that is, right about now), we begin an endless series of arguments about what we think the most important issues are in ETFs, and what that means for investors and advisors for the next year.

One of the strong contenders—at least from my side of the argument—is investing based on environmental, social and governance factors (generally shorthanded to “ESG”), and also commonly referred to as “socially responsible.” With two interesting sessions on the agenda already, it seems inevitable there will be some great discussion to be had down in Florida.

Alphabet Soup

One of the biggest issues with ESG is definitional—much like “smart beta.”  The phrase gets tossed around to include any number of potential products, from funds that explicitly invest based on a particular religious belief system to those that simply remove “sin stocks” and those that choose companies with strong pro-labor policies.

This definitional problem remains one of the great plagues of ESG investors, but it’s almost inevitable. Individual investors can often find easy common ground: Downside volatility is generally bad. Performance, strong balance sheets and momentum are generally good. Taxes? Always bad.

But in the 1980s, when ESG got its start, some of the largest pensions and endowments began to think about noneconomic issues in their portfolios, and the discussions were extremely targeted. Harvard sold out of Citicorp debt to protest South Africa’s apartheid, followed by states and municipalities outright barring any investment in South Africa.

Definition Debate

Later in the decade, big pensions started using their proxy powers to force action from firms like Exxon on specific, targeted issues, like the Valdez spill response.

Through the 1990s, dozens of small firms started cropping up to rate and rank individual firms based on everything from environmental impact to labor friendliness to executive compensation policies.

This slow burn of narrow, individualized ESG definitions has led us to a world where no two people can agree on what ESG even means. For example, inside MSCI’s monster index factory, there are more than 700 indexes on offer with some sort of ESG or values-based screen, ranging from Shariah-compliance to low-carbon output.

 

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