A Deeper Dive Into ESG ETF Portfolios

August 31, 2017

The world is full of model ETF portfolios, but we’re just starting to see the environmental, socially responsible and governance (ESG) filter as a consideration on many. The biggest recent news on this front was the development by robo-platform Betterment of an ESG version of its core portfolio last month.

I thought this would be a timely opportunity to look at some popular portfolios and see how they stack up using the MSCI ESG data we’re now featuring here at ETF.com. (For a primer on what that data is, see my article from June when we launched it.)

Let’s start by looking at the portfolio my friend Matt Hougan puts together every year here on ETF.com, the world’s cheapest portfolio. 

 

The Hougan Portfolio

Exposure Weight Ticker Name Expense
Ratio
ESG
Score
SIS % SRI
Exclusion
%
MSCI ESG Score
U.S. Equity 40% ITOT iShares Core S&P Total U.S. Stock Market ETF 3 4.938 6.23 10.64 5.17
Developed Markets 30% SCHF Schwab International Equity ETF 6 6.285 6.12 10.97 6.58
Emerging Markets 5% SCHE Schwab Emerging Markets Equity ETF 13 4.389 3.16 3.25 3.45
Fixed Income 15% SCHZ Schwab US Aggregate Bond ETF 4 6.228 0.91 2.40 6.00
REITS 5% SCHH Schwab U.S. REIT ETF 7 4.036 9.83 0 4.27
Commodities 5% COMB GraniteShares Bloomberg Commodity Broad Strategy No K-1 ETF 25       6.89
        5.85 5.49 5.38 8.49  

 

 

This portfolio doesn’t have any considerations other than cost, and an essentially random asset allocation. “Cheap” is definitely the word for it—with a weighted average expense ratio of just 0.058%, it’s so close to free as to not even matter. You can stick $1 million in this portfolio and pay less for it a year than it would cost to see Hamilton.

But how does it look from an ESG lens? Put simply, pretty much middle of the road.

The U.S. equity choice here scores an overall 5, which conveniently also puts it right about the 50th percentile among U.S. total market funds. The same is true of the developed-market equity exposure—most developed markets score better than the U.S. (Europe and Japan generally have stronger governance, diversity, labor and environmental regulations), so it’s pretty middle of the road as well.

 

The bond exposure is pretty good though, with some caveats: the MSCI methodology gets thin on the ground when it comes to covering debt issuers. Of the bonds in the Schwab US Aggregate Bond ETF (SCHZ), only 68% are actually tracked and measured back to the issuer. Still, SCHZ is in the 88th percentile for overall “ESG-ness” among peer funds. (I’ve removed the commodity allocations from the averages, as MSCI doesn’t cover, say, wheat, from an ESG perspective.)

The last two columns here represent the percentage of the funds in “do good” stocks that are working toward things like clean energy and affordable housing; and the “sin” stocks, like companies that make land mines and booze. The numbers here are pretty representative of the broad markets, which is unsurprising.

Robo Conscience

With that backdrop, let’s see how the new Betterment portfolio looks—compared to both Matt’s dumb-and-cheap portfolio, and the basic Betterment portfolio it’s competing against:

 

Betterment Vanilla

Exposure Allocation Ticker Name Expense
Ratio %
ESG
Score
SIS % SRI
Exclusion
%
MSCI ESG Score
U.S. Total Market 12.90% VTI Vanguard Total Stock Market ETF 4 4.9053 6.26 10.64 5.18
U.S. Large Cap Value 12.90% VTV Vanguard Value ETF 6 5.234 4.70 18.18 5.38
U.S. Mid Cap Value 4.10% VOE Vanguard Mid-Cap Value ETF 7 4.6921 3.30 9.98 5.05
U.S. Small Cap Value 3.60% VBR Vanguard Small-Cap Value ETF 7 3.9027 2.99 5.59 3.76
Developed Markets 30.10% VEA Vanguard FTSE Developed Markets ETF 7 6.2129 5.83 10.40 6.46
Emerging Markets 6.30% VWO Vanguard FTSE Emerging Markets ETF 14 4.352 2.69 3.07 3.39
U.S. Corp Bond 1.70% LQD iShares iBoxx $ Investment Grade Corporate Bond ETF 15 4.7564 5.49 11.81 4.80
International Bonds 6.90% BNDX Vanguard Total International Bond ETF 12 6.1994 0.57 1.65 6.23
Emerging Market Bonds 4.20% EMB iShares JP Morgan USD Emerging Markets Bond ETF 40 4.0196 0 0.77 2.94
Municipal Bonds 17.20% MUB iShares National Muni Bond ETF 25        
        11.89 5.40 4.73 9.67  

 

Betterment SRI

Exposure Allocation Ticker Name Expense
Ratio %
ESG
Score
SIS % SRI
Exclusion
%
MSCI ESG Score
U.S. Large Cap 23.10% DSI iShares MSCI KLD 400 Social ETF 50 6.3856 12.08 0.35 7.50
U.S. Mid Cap Growth 1.00% VOT Vanguard Mid-Cap Growth ETF 7 4.6352 11.58 1.84 4.70
U.S. Mid Cap Value 5.30% VOE Vanguard Mid-Cap Value ETF 7 4.6921 3.30 9.98 5.05
U.S. Small Cap Growth 0.30% VBK Vanguard Small-Cap Growth ETF 7 3.9554 6.31 2.13 3.44
U.S. Small Cap Value 4.00% VBR Vanguard Small-Cap Value ETF 7 3.9027 2.99 5.59 3.76
Developed Markets 30.10% VEA Vanguard FTSE Developed Markets ETF 7 6.2129 5.83 10.4 6.46
Emerging Markets 6.30% VWO Vanguard FTSE Emerging Markets ETF 14 4.352 2.69 3.07 3.39
U.S. Corp Bond 1.70% LQD iShares iBoxx $ Investment Grade Corporate Bond ETF 15 4.7564 5.49 11.81 4.80
International Bonds 6.90% BNDX Vanguard Total International Bond ETF 12 6.1994 0.57 1.65 6.23
Emerging Market Bonds 4.20% EMB iShares JP Morgan USD Emerging Markets Bond ETF 40 4.0196 0 0.77 2.94
Municipal Bonds 17.20% MUB iShares National Muni Bond ETF 25       N/A
        22.32 5.74 6.70 5.46  

 

 

A few things to note here: First, Betterment’s vanilla portfolio—which they kindly provided me at a similar 70% equity allocation to Matt Hougan’s—makes a few different choices than Matt. It’s still hunting for cheap, but it’s clearly also looking for liquidity.

When Betterment chooses an ETF, it ends up steering hundreds of millions of dollars around. When Matt chooses an ETF, it happens in an academic vacuum where trading is free and market impact is irrelevant. While funds like the Schwab International Equity ETF (SCHF) are plenty liquid for any individual investor, the Vanguard funds here are almost 10 times as liquid, or more.

Second, both of these portfolios include muni bonds, which, like commodities, aren’t rated by the MSCI ESG methodology, so I’ve pulled them from the calculations.

The Big Difference

So what’s the conclusion here? Surprisingly, the major difference between these two portfolios—and indeed between the SRI portfolio and Matt’s—is simply the inclusion of the iShares MSCI KLD 400 Social ETF (DSI) in place of a big chunk of the U.S. equity exposure. On the surface, this has a huge impact on expenses—nearly doubling the overall portfolio expense—and not much impact on the weighted average score, which goes up from 5.4 to 5.74.

But here’s where I think it pays to look under the hood. If you really care about owning companies that are doing good—and avoiding those doing, well, bad—then this SRI spin makes a difference. The percentage of “good” companies goes up by 2%, and the percentage of “bad” companies drops by more than 4%. It’s up to you whether you think that matters, but it’s not insignificant, and belies the raw score a bit.

Can You Do Better?

Since Betterment is making a bit of a big deal over its SRI alternative, I thought it might be worth looking at its biggest competitor, Wealthfront. Here’s a sample portfolio I was able to extract that gets pretty close in terms of overall exposure weights to both Matt’s and Betterment’s vanilla portfolios.

 

Wealthfront

Exposure Allocation Ticker Name Expense
Ratio %
ESG
Score
SIS % SRI
Exclusion
%
MSCI ESG Score
U.S. Equity 33% VTI Vanguard Total Stock Market ETF 4 4.9053 6.26 10.64 5.18
Intl. Equity 15% VEA Vanguard FTSE Developed Markets ETF 7 6.2129 5.83 10.40 6.46
Emerging Markets 12% VWO Vanguard FTSE Emerging Markets ETF 14 4.352 2.69 3.07 3.39
Dividends 6% VIG Vanguard Dividend Appreciation ETF 8 5.617 4.98 15.26 6.07
Natural Resources 5% XLE Energy Select Sector SPDR Fund 14 4.128 0.10 2.03 5.62
Municipal Bonds 29% VTEB Vanguard Tax-Exempt Bond ETF 9       N/A
        7.84 5.09 5.02 9.09  

 

 

Like Betterment, Wealthfront leans hard on Vanguard for that magic combo of cost and liquidity. The end result is a surprisingly similar portfolio, with a slightly lower all-in expense average (0.0784% vs. 0.1189%), but also a slightly worse starting point from an ESG perspective (5.09 vs 5.40).

The question is, is it possible to really move the needle here with the existing ETFs in the marketplace? The short answer is yes.

Here’s a crack at the same allocations from Matt’s portfolio, but instead of focusing on cost, it focuses “only” on the ESG rating for the desired exposures:

 

ETF.com's Super ESG Portfolio

Exposure Allocation Ticker Name Expense
Ratio %
ESG
Score
SIS % SRI
Exclusion
%
MSCI ESG Score
U.S. Equity 40% SUSA iShares MSCI USA ESG Select ETF 50 8.1991 9.05 5.22 8.73
Developed Markets 30% ESGD iShares MSCI EAFE ESG Optimized ETF 40 7.4391 8.02 10.26 8.05
Emerging Markets 5% ESGE  iShares MSCI EM ESG Optimized ETF 45 5.7248 5.06 1.85 5.91
Fixed Income 15% SCHZ Schwab US Aggregate Bond ETF 4 6.2283 0.91 2.40 6.00
REITS 5% SCHH Schwab U.S. REIT ETF 7 4.0355 9.83 0 4.27
Commodities 5% COMB GraniteShares Bloomberg Commodity Broad Strategy No K-1 ETF 25       6.89
        36.45 7.30 7.27 5.91  

 

Here we’ve leaned hard not on super-cheap Vanguard or Schwab, but on a slew of newfangled ESG launches from BlackRock, the iShares ESG series. You can’t do better than either of the two Schwab products for your real estate and bond exposure, so we’ve left those intact.

The impacts are significant. The overall rating of the portfolio climbs from the 5s up to 7.3, making it as ESG friendly as dedicated individual funds in the space. The “good stock” percentage climbs to 7.27% and the “bad stock” percentage gets under 6%.

But it comes at a real cost. The expense of this portfolio gets pretty pricey indeed. While 0.36% still seems like a deal when compared to some actively managed mutual funds charging over 1%, there is no getting over the fact that this feel-good portfolio costs six times more than Matt’s super-cheap version.

The other thing worth noting is that you can do better, depending on what’s important to you.

 

If you’re focused “only” on, say, avoiding sin stocks, you can do a lot better than the iShares MSCI EAFE ESG Optimized ETF (ESGD) by choosing the PowerShares DWA Developed Markets Momentum Portfolio (PIZ). That fund makes no claim about either providing broad exposure to ex-U.S. stocks, or to keeping sin stocks out, but its momentum-chasing approach results in a portfolio with just 2.88% sin stocks.

You want nothing but do-gooders? Swap out all the equity exposure for the iShares MSCI Global Impact ETF (MPCT), which holds just 87 companies from all over the world, 75% of which pass the Sustainable Impact Solutions test.

Balancing Act

All of those choices have real consequences. Not only do most of these ETFs cost substantially more, some of them start entering the realm of being tricky to trade. MPCT, for instance, trades just a few thousand shares on an average day, making it a leap of faith to use for most people’s core allocation, and a nonstarter for big firms like Wealthfront or Betterment.

It’s great to see folks like Betterment cracking open the ESG egg. I’m quite confident that as ESG investing continues to catch on, more ETFs will have the liquidity and the track record to make their efforts even more meaningful.

In the meantime, it always pays to do your homework and determine what you’re really asking of your investing dollar. After all, it’s yours.

At the time of writing, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].

 

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