2 Socially Responsible ETFs That Work

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.

A Price For Your Conscience

The two funds have annual expense ratios of 50 basis points, or $50 for each $10,000 invested. That’s a lot compared with the plain-Jane ETFs that charge less than 10 basis points. Moreover, most “smart beta” funds charge a middling 30-35 basis points.

So there it is in black and white: Your conscience costs 40 basis points a year. Is that worth it to you?

It is to a good many investors judging by the $500 million in combined assets under management in both funds.

And just who are these investors? While you might think that investing in an ESG ETF puts you in league with Prius drivers, composters and other subversives, in fact, you’ll be aligned with massive pension funds and other powerful institutional investors, as noted in a recent Wall Street Journal piece.

Other Fish In The ESG Sea

While KLD and DSI are the ESG pure-play ETFs, other funds have related themes. Three ETFs neatly cover the E, S and G parts of ESG investing, respectively. Note that costs are high and assets are low for some of these funds—click on the links for more.

• The Huntington EcoLogical Strategy ETF (HECO | C-48) uses environmental screens and comes with high all-in costs, beginning with an annual expense ratio of 95 basis points.
• The Workplace Equality ETF (EQLT) focuses on a narrow but timely social theme: workplace equality for LGBT folks. The fund, which has an annual expense ratio of 75 basis points, is still quite new, so trade with care.
• The Vident Core U.S. Equity ETF (VUSE) uses “governance” metrics but also includes screens for risk and other factors. The ETF has an annual expense ratio of 55 basis points.
• Finally, the AdvisorShares Global Echo ETF (GIVE | D-69) employs a multimanager, multi- asset approach, so it’s not a substitute for core equity exposure. Part of its high fee of 161 basis points—$161 for each $10,000 invested—goes to charity.

‘Smug’ Beta?

So, is ESG for you?

If nothing else, the extra 40 basis points in expense ratio costs might make you feel a bit better about yourself when talking stocks with your neighbor. “You own Exxon Mobil? I guess you don’t care about the planet.”

All kidding aside, sometimes corporations screw up pretty bad. Who among us hasn’t felt the flash of anger at the latest oil spill or board shenanigan, only to mutter “I probably own the darn stock.”

In the end, ESG investing is a small but concrete step that directs your resources to companies that aim to do the right thing.

At the time this article was written, the author clearly didn’t care about the planet and held no positions in the securities mentioned. Contact Paul Britt at [email protected].