One of the biggest ETF trends in 2016 has been the expansion of socially responsible ETFs, which also carry the label of "environmental, social and governance," or "ESG" if you need another acronym in your ETF alphabet soup.
The idea is that these ETF investments adhere to "principles" that will dictate the underlying exposure, such as excluding companies that make money selling fossil fuels or guns or liquor, or for not promoting enough women, or some other perceived sin.
Some are actually designed with a specific religious bent, such the recently launched Global X S&P 500 Catholic Values (CATH).
CATH, which has attracted $21 million in assets in three months, tracks a cap-weighted index of U.S. large-cap stocks selected from the S&P 500 and omits companies from certain industries at odds with Catholic values. Those "values," or the screener that you would be investing in, is determined by the U.S. Conference of Catholic Bishops.
What Gets In?
From CATH's ETF.com fund report, powered by FactSet: "CATH has zero tolerance for firms with any revenues from unconventional weapons, contraception, abortion, stem-cell research and pornography production … Firms with evidence of using child-labor are also omitted."
You get what you would expect if you know anything about being Catholic, which was how I was raised. But there is also this caveat: "Conventional weapons sales can account for a maximum of 50% of revenues."
And despite these pious index rules, "most stocks make it through the screen. The fund minimizes the investment impact of the divestment by maintaining cap-weighted sector exposure, and cap-weighted exposure within each sector. CATH charges a competitive fee for its basket," our fund report concludes.
So think broad market with a feel-good vibe, the kind you get from hearing a great sermon. Since its inception on April 18, through Aug. 4, CATH was up 3.66% versus the SPDR S&P 500 ETF Trust (SPY), which was up 3.96%.
'SHE's The One'
There are currently 23 socially responsible ETFs listed in the U.S. market. Nearly half of those have launched this year, basically doubling the number of products on the market.
The best-performing of them all is a newcomer launched in March (which means it missed the February drop), the SPDR SSGA Gender Diversity Index ETF (SHE), which is up nearly 10%, outperforming the broad market.
SHE tracks a market-cap-weighted index of U.S. large-cap companies with a relatively high proportion of women in executive and director positions.
Construction Vs. Principle
From SHE's ETF.com fund report: "The fund evaluates the 1,000 largest US firms for the ratio of women on the board of directors and in executive positions (defined as Sr. VP or higher). Companies ranking in the top 10% in each sector are included in the portfolio, with the caveat that each firm must have at least one woman on its board or as CEO."
That would seem to be a heavy screener with the underrepresentation of women in executive positions, but the fund's construction, like with CATH, lightens the filter.
"Holdings are market cap-weighted. Selecting firms by sector and weighting them by market cap means that SHE's performance shouldn't depart radically from the broad market, appealing to investors who want neutral large-cap coverage while still supporting the fund's principles. SHE launched in March 2016, and charges a reasonable fee," our fund report concludes.
So again, the underlying exposure is broader than it may appear.
Older Funds Not Far Off
The next four best performers have a full-year track record, and only one is beating SPY. No. 2 is the iShares MSCI USA ESG Select ETF (KLD) which is up 8.75% and has $400 million in assets, followed by the iShares MSCI KLD 400 Social ETF (DSI), up 7% (more than $575 million in AUM); the SPDR MSCI ACWI Low Carbon Target ETF (LOWC), up 5.6% ($94 million); and the iShares MSCI ACWI Low Carbon Target ETF (CRBN), up nearly 4% ($237 million), which lags CATH.
Chart courtesy of StockCharts.com
The last two, LOWC and CRBN, track the MSCI ACWI Low Carbon Target Index and both charge 0.20%. The funds aim "to favor stocks from firms with lower greenhouse and carbon emissions (relative to firm size) while maintaining very tight tolerances to a broad and market-like index, the MSCI ACWI," according to our fund reports on the two.
Again, the construction looks to minimize the investment thesis with broad market tilts.
More Broad Tilts
KLD and DSI are broader environmental, social and governance plays. I suspect more new products will look like these. They use indexes from MSCI that weight according to ESG scores as factored by MSCI.
KLD "caps security weights at 5% and limits sector deviation from the broader MSCI USA index to 3%, ensuring that the fund doesn't deviate wildly from the broader equity market," our fund report says. And DSI maintains reasonable "market-like exposure. While the fund excludes a lot of familiar names, like Apple, Exxon Mobil and AT&T, it avoids making huge sector bets."
Built With Safety In Mind
As you can see from the table below, other ETFs in the space reflect the same themes on the environment or about gender and race, or workplace issues in general. And there are other mitigation tilts like equal weighting for funds with narrow focus and heavier screens.
Beyond the funds mentioned, the rest of the SRI funds have few assets under management and can have trading spreads of 9%(!). More of these types of funds are coming and the competition for investors will be difficult.
The biggest obstacle may be convincing investors that socially responsible ETFs really don't have that narrow of a focus, despite their labels, at least with the ones on the market now. They are built with safety in mind, built with the idea of not losing sight of the broad market.
These "feel-good beta" funds are a prudent way to express your socially responsible investment leanings. How much "principle" is sacrificed is left in the eye of the beholder.
At the time of writing, the author owned none of the ETFs mentioned. Drew Voros can be reached at [email protected].