Putting Social Minded Investing In Focus

June 18, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.


By now, it should be clear to anyone following ETFs that a new craze is perhaps inevitable. It’s been a continual cycle for ETF issuers. So what will be the next craze to hit the ETF landscape? And how can we get in on the ground floor, or how can we differentiate our offering from others?


By way of background, right now, we seem to be in the midst of a few powerful waves of new issues. They are:

  • "Smart beta," with an ever-growing number of ETFs slicing and dicing the investment universe with different methodologies in ways that are proving to be popular amongst ETF investors.
  • Another wave is the increasingly discussed hedged ETFs, whether it’s the currency-hedged form that has become more popular with recent dollar strength, or the interest-rate-hedged variety that stands ready to take advantage of any possible rise in interest rates.


Both of these trends have their roots in the institutional landscape.


Institutional managers have long used smart beta—in particular, factor investing and currency hedging in their various mandates. Given that trends in ETF issuance ideas often stem from the institutional space, what could be the next wave to hit ETF-land?


I submit that the answer could be environmental, social and governance-focused (ESG) investing.


Why ESG, And Why Now?

To be clear, ESG investing is neither a new phenomenon nor a small consideration. A report from the Forum for Sustainable and Responsible Investment show that assets managed with ESG—including socially responsible investing (SRI)—guidelines grew from $3.74 trillion in 2012 to $6.57 trillion by 2014.


The top four reasons, according to the report, for offering ESG investment options were:

  1. Client demand
  2. Mission fulfillment
  3. Improving returns
  4. Managing risk


However, as of yet, this growth has not carried over into ETF-land. Currently there are 10 ETFs with SRI/ESG mandates, with aggregate assets under management of only $1.27 billion. They’re displayed in the table below.


Ticker Fund Assets ($MM)
DSI           iShares MSCI KLD 400 Social 442.32
KLD           iShares MSCI USA ESG Select Social 338.79
CRBN           iShares MSCI ACWI Low Carbon 164.92
LOWC           SPDR MSCI ACWI Low Carbon 92.53
ICLN           iShares Global Clean Energy 85.65
PZD           PowerShares CleanTech Portfolio 77.50
RODI           Barclays Return on Disability 30.45
WIL           Barclays Women in Leadership 29.17
EQLT           Workplace Equality Portfolio 8.63
FIA           Falah Russell-Ideal Ratings US Large Cap 1.31


It should be noted that the United Nations Joint Staff Pension Fund seeded both the iShares MSCI ACWI Low Carbon Target ETF (CRBN | D-94) and the SPDR MSCI ACWI Low Carbon Target ETF (LOWC | D-95).



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

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.



Return 6.77% 5.48%
St Dev 15.87% 16.27%
10/9/07-3/9/09 -53.72% -56.67%


The bottom line appears to be that the more exclusionary process for DSI led to a significantly better return, standard deviation and drawdown as compared with the base benchmark (not even taking the 50 basis point expense ratio into effect).


Based on this analysis, it appears both of these ETFs accomplished their improved risk/return goals, just to varying degrees. KLD takes the more passive route and more closely tracks it base benchmark, while DSI takes a more active exclusionary approach. However, both provide the “peace of mind” to investors that they are supporting companies/industries objectively determined to be more responsible.


Additionally, both ETFs seem to be gaining some traction. Since the end of Q3 2014, both ETFs have seen shares outstanding grow by about 15 percent.



ESG investing has long been used in the institutional space. While other institutional-type strategies have flourished in ETF form, we may be on the precipice of ESG following suit.



At the time of writing, the author’s firm held no shares of any of the securities mentioned. The above constitutes the personal, professional opinion of Clayton Fresk, CFA, and does not reflect the views of Stadion Money Management LLC. References to specific securities or market indexes are not intended as specific investment advice.

Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-7636 or www.stadionmoney.com.



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