Putting Social Minded Investing In Focus

June 18, 2015

 

Under The Hood Of ESG ETFs

As noted above, two of the top reasons for offering ESG options were improving returns and managing risk. So have ESG portfolios actually succeeded in this?

 

For the following analysis, I'll concentrate on the two largest ETFs from the list above, which are also the broadest in terms of underlying investments/index as well as having a significantly longer track record than the other ETFs listed.

 

Both the iShares MSCI KLD 400 Social ETF (DSI | B-92) and the iShares MSCI USA ESG Select ETF (KLD | B-88) start with similar base indexes. DSI is based on the MSCI USA IMI Index and KLD is organized around the MSCI USA Index.

 

While similar in certain ways, a main difference in the two ETFs is that DSI looks to be more exclusionary than KLD. While both exclude tobacco companies, DSI also excludes nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, GMOs and adult entertainment.

 

In addition, KLD looks to maximize the exposure to companies with high ESG scores while maintaining similar risk/return characteristics to the base index, and DSI excludes companies with insufficient ESG and Impact scores.

 

Looking At ESG Scores

These ESG scores are based on a proprietary MSCI methodology. Similar ESG scoring can be obtained through Bloomberg via Sustainalytics rankings, which assign companies an overall score as well as separate social, governance and environmental ranks.

 

To simplify, KLD looks to be more like other smart-beta offerings in that it uses ESG considerations as the driving factor to differentiate it from the "regular" beta index. On the other hand, DSI is much more in the active-type camp, and only uses the base index as a starting point for its security selection/exclusionary process.

 

Starting with KLD, the table below shows the return and standard deviation (monthly data) since its inception at the end of January 2005 through May. Those are the first two rows of the table below, and the third row is a snapshot of the fund’s performance from peak-to-trough going into the financial crisis.

 

Analyzing Returns

  KLD NDDUUS
Return 7.10% 7.54%
St Dev 14.66% 14.59%
10/9/07 - 3/9/09 -53.93% -55.36%

 

After taking into account the annual expense ratio of 50 basis points, or $50,000 for each $10,000 invested, KLD is very close to the characteristics of the base index. Additionally, it provided a minimal amount of increased downside protection during the last bear market. Therefore, at a quick glance, even if muted, KLD did provide some risk/return benefits.

 

Next, I will look at the same analysis for DSI versus its base benchmark from inception at end of November 2006 through May. Those are the first two rows of the table below, and the third row is a snapshot of the fund’s performance from peak-to-trough going into the financial crisis.

 

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