Sleep like a baby at night while these ETFs earn marketlike returns by day.
Smart-beta ETFs—all the rage these days—rely on factors to pick the stocks in their portfolios. Typically these factors are cold, hard numbers, like price-earnings multiples (P/E ratios), dividend yield or other quantitative factors.
But for investors who use ETFs for long-term core allocations, there’s a “peace-of-mind” factor too.
Investors need to be able to live with their investment choices, and there’s a factor that might keep us awake at night after listening to the evening news: the fear that companies we invest in are lousy citizens of the world.
That’s where “ESG” investing comes in. ESG stands for environmental, social and governance. Investment vehicles with an ESG thesis focus on firms that don’t pollute the planet, are good corporate neighbors and run their boards in a thoughtful way.
The ESG Pure-Plays
Two ETFs stand out to me as “pure play” ESG funds: the iShares MSCI KLD 400 Social ETF (DSI | B-90) and the iShares MSCI USA ESG Select ETF (KLD | B-85). They both have long track records and healthy asset bases.
What strikes me as positive about the portfolios and performance of these funds is what they don’t do. They don’t make massive sector bets. They don’t reach far down the market-cap spectrum to grossly overweight midcap and small-cap firms.
In other words, their exposure and their returns are reasonably marketlike. That means you can have your cake and eat it too. You can sleep better at night knowing you’re investing in do-gooder firms while maintaining performance that’s no better or worse than a plain-vanilla index fund.
OK, maybe it’s a little different. But one-, three- and five-year returns are quite comparable to cap-weighted benchmark (see our fund reports), as are performance statistics such as r-squared and beta.
A Few Surprises
What should you expect to find in an ESG portfolio? Perhaps a “no” to stinky energy firms and a “yes” to warm and fuzzy health care. Maybe throw in value bias since it all amounts to a “values” thesis.
Well, that’s mostly bunk.
While both funds underweight energy, KLD underweights health care, and both funds lean toward growth. Both overweight tech too. These biases aren’t huge, but they may run counter to your preconceptions. So by all means, take a moment to look under the hood.
After all, an ESG fund that matches the market perfectly is probably toothless. But I didn’t find any deal-breakers in the fund.