A key takeaway is that, in addition to considering fundamental criteria such as cost and portfolio turnover/tax-efficiency, investors—and their advisors—need to take the time to “look under the hood” and understand the rules governing the underlying index that each fund tracks, to ensure that the fund’s goals are aligned with theirs.
Even broad-based funds have some important differences in the criteria they use to include and exclude securities. Furthermore, ESG selection criteria can result in particular industry sector biases, with consequent potential risks.
Among domestic funds, four ETFs met our search criteria.
The two ETFs that have the broadest ESG screens also happen to be the oldest and largest ETFs in this category: The first is the iShares MSCI KLD 400 Social ETF (DSI).
Launched by Barclays (BlackRock iShares’ predecessor) in 2006, DSI tracks the first and perhaps most well-known ESG index in the U.S., formerly known as the Domini 400 Social Index—a float-adjusted, market-cap-weighted index with screens based on a comprehensive range of ESG criteria.
As of this writing, it excludes some well-known names, including Apple (currently the largest company in the U.S. by market capitalization), and is relatively overweight in technology stocks and underweight in financial stocks compared to the broad U.S. market.
Interestingly, before DSI, an open-end mutual fund now known as the Domini Social Equity Fund (DSEFX) tracked this index. However, DSEFX transitioned to an active strategy at the time DSI was launched, and concurrently increased its gross annual operating expense ratio, which is presently 1.16%.
By contrast, DSI, the index tracker, carries a 0.50% annual expense ratio. The fund has almost $748 million under management and 400 holdings, and its trading volume, as of this writing, is roughly 35,000 shares.
This second iShares ESG ETF, KLD, originally tracked a condensed (“select”) version of the Domini 400 Social Index, and in 2010, switched to an entirely new index independent of the Domini 400.
It is designed to exhibit risk and return characteristics similar to those of the unscreened MSCI USA Index. As such, the fund caps sector deviation from this broader benchmark at 3%. Even so, both KLD and DSI currently exhibit similar industry sector weightings. KLD has fewer holdings than DSI (about 115 versus roughly 400) and thus a slightly higher concentration in terms of its largest holdings (including, interestingly, Apple).
Like DSI, KLD carries an annual expense ratio of 0.50%. However, investors should note that it is a smaller fund than DSI, with slightly more than $475 million under management, and trades with a lower average volume of about 17,000.
The other two ETFs that met our search criteria are newer and have narrower ESG objectives: