In any otherwise-crowded ETF industry, socially responsible exchange-traded funds, also known as ESG (environmental, social, governance) funds, are one of the few nascent areas. Currently, there are nearly 40 such strategies on the market today with a total of $3.1 billion in assets under management―a tiny amount compared to the 2,000-plus U.S.-listed ETFs out there with $3 trillion in total.
But growth in the space has been accelerating. At this time last year, there were only 22 socially responsible or ESG exchange-traded funds available.
Not All The Same
Also known as ethical investing, impact investing, principles-based investing, sustainable investing and others, these strategies consider "environmental, social, and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact," according to the Forum for Sustainable and Responsible Investment.
“Socially responsible” is a blanket term, but the principles that such ETFs follow often vary dramatically. Take the Inspire Global Hope Large Cap ETF (BLES), which considers "biblical values" when picking its investments. It screens out companies associated with abortion, gambling, and "the LGBT lifestyle," among other things.
That's in sharp contrast to a fund such as the Workplace Equality Portfolio (EQLT), which holds stocks of companies that "support LGBT equality in the workplace."
Meanwhile, there are other ETFs that are laser-focused on completely different causes such as environmentalism and corporate governance.
China ETFs Ex-State-Owned Enterprises
This year's top-performing principles-based funds are concerned with the latter―corporate governance―which is "the structures and processes by which companies are directed and controlled," according to the International Finance Corporation.
The WisdomTree China ex-State-Owned-Enterprises Fund (CXSE) and the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE) are up 48.5% and 32.6%, respectively, year-to-date.
As their names suggest, these two ETFs exclude state-owned enterprises from their holdings, which is defined as government ownership of more than 20%.
Less government control is typically seen as a good thing by investors, and this year's returns for CXSE and XSOE clearly support that view. In the U.S., where government ownership of companies is almost nonexistent, good corporate governance involves independent board of directors, shareholder voting rights, accountability for management, gender equality representation in management, reasonable pay for executives, and things of that nature.
Keeping Marketlike Exposure
In some cases, an investor may want to make a principles-based investment, but without straying too far from marketlike exposure. There are a handful of funds that fit the bill. Two of those are among the best-performing ETFs in the space this year: the iShares MSCI EM ESG Optimized ETF (ESGE) and the iShares MSCI EAFE ESG Optimized ETF (ESGD), up 25.6% and 17.1%, respectively.
These companies aim to provide risk and reward similar to their respective MSCI Emerging Markets and EAFE indices while obtaining greater exposure to companies with strong ESG traits. The strategies have worked well this year, delivering returns within 1% of their plain-vanilla counterparts.
Likewise, another pair of ETFs that aims to maintain market-like exposure, while elevating certain do-good companies within their holdings, are the iShares MSCI ACWI Low Carbon Target ETF (CRBN) and the SPDR MSCI ACWI Low Carbon Target ETF (LOWC), each up around 15% this year.
Both these ETFs track the same index, selecting companies that have relatively lower carbon footprint than the broader MSCI ACWI index. Even so, returns for the ETFs have been right in line with the broader market.
More Aggressive Choices
For investors who aren't concerned with keeping their exposure close to the broader market, a number of more aggressive ETFs exist. The iShares MSCI Global Impact ETF (MPCT), up 18.3% year-to-date, tracks an index of companies that "derive a majority of their revenue from products and services that address at least one of the world's major social and environmental challenges as identified by the United Nations Sustainable Development Goals."
Then there's the Columbia Sustainable International Equity Income ETF (ESGN), which may appeal to income investors. It holds companies that have a minimum dividend yield of 1%, while excluding those that have unfavorable corporate ESG practices.
Clearly, ESG ETFs come in many forms. Some don't stray far from the market, while others do. Some target a specific cause, while others focus on many. It's up to each investor to look under the hood to see what principles and selection criteria these ETFs are adhering to before buying.
A full list of these funds can be found on the ETF.com screener and database by choosing "Principles-based" under the "Selection" tab after clicking "More Filters."
To see this year's 10 top-performing socially responsible ETFs, see the table below:
Data as of July 20, 2017
Contact Sumit Roy at [email protected]