Critics of this brand of investing note that meeting environmental or social objectives isn’t always an exact science. While the SPDR S&P 500 Fossil Fuel Reserves Free ETF (SPYX) excludes companies with fossil fuel reserves, for example, it still includes energy equipment and service providers such as Halliburton and Valero. In an effort not to deviate too broadly from mainstream benchmark indexes, both DSI and KLD have ample representation in energy and industrial companies.
The ESG/ETF Menu
Despite their common label, ESG-focused ETFs are a diverse group. Some focus on companies with the strongest ESG practices. Others screen out sin stocks while still applying ESG criteria and maintaining representation in a broad range of sectors.
A few occupy narrow niches such as alternative energy and focus on smaller companies, so their performance is likely to be more volatile than the broader-based offerings. Many are newer, so their small asset bases could present liquidity constraints.
The largest broad market players in this category are the iShares MSCI USA ESG Select ETF and the iShares MSCI KLD Social 400 ETF, with $426 million and $627 million in assets, respectively. The latter uses ESG screens and excludes companies involved with alcohol, tobacco, gambling, civilian firearms, nuclear power, military weapons, adult entertainment and genetically modified organisms. The former also uses ESG criteria in its selection process, but only excludes tobacco companies.
Both ETFs draw their constituents from the MSCI USA Investable Market Index (IMI), although the iShares MSCI USA ESG Select ETF hews a bit more closely to its sector weightings.
Because both are market-cap-weighted and place limits on how much sector weightings can deviate from their non-ESG benchmark, they are suitable as diversified core offerings.
In addition, iShares this summer launched two other exchange-traded funds with ESG mandates for international investors: the iShares MSCI EAFE ESG Select ETF (ESGD) and iShares MSCI EM ESG Select ETF (ESGE).
Smart beta recently made its way into the category when Columbia Threadneedle Investments in June introduced the Columbia Sustainable U.S. Equity Income ETF (ESGS), the Columbia Sustainable International Equity Income ETF (ESGN) and the Columbia Sustainable Global Equity Income ETF (ESGW).
The security selection methodology for these ETFs scores and ranks companies based on the security of their dividend yields, dividend growth and cash-based dividend coverage ratio factors, as well as environmental, social and governance (ESG) standards. As of late September, each of the funds had about $5 million in assets and had not made any dividend distributions.
Specialty/Niche
The SPDR SSGA Gender Diversity Index ETF mentioned above tracks an index of U.S. large-cap companies that are leaders within their respective industry sectors in advancing women through gender diversity on their boards of directors and in senior leadership positions. Its weighted average market capitalization is $65 billion, and it has a respectable yield of 1.77% and an expense ratio of 0.20%. Since most of its $280 million in assets are attributable to a single pension system, liquidity could be an issue here.
The SPDR MSCI ACWI Low Carbon Target ETF (LOWC) is based on an index of global companies that have lower greenhouse gas and carbon emissions, relative to sales and market cap. This is not a pure “clean energy” play. Instead, sector constraints relative to its parent MSCI ACWI Index make it more of a broad-based fund with a green bias. A similar product, the iShares MSCI ACWI Low Carbon Target ETF (CRBN), tracks the same index.
Both ETFs were launched in late 2014, so they have short track records. Over the five years ending August 31, the MSCI ACWI Low Carbon Target Index, which both ETFs are based on, returned 8.7% annualized. That’s a bit better than the return of the unfiltered MSCI ACWI Index, which had an annualized return of 8.3%.
In selecting ETFs with a sustainable bent, it’s important to ask clients which practices they want to emphasize most. For some, it may be gender diversity, religious values or the environment. Others may simply want a broad-based investment with a general ESG overlay. As the number of ETFs with ESG criteria continues to proliferate, the notion that investors of all stripes can adhere to principles they feel strongly about, while still achieving competitive returns, is likely to gain broader acceptance.
Marla Brill is a financial writer specializing in exchange-traded funds and mutual funds. A regular contributor to Financial Advisor magazine, her work has appeared in MarketWatch, The Boston Globe, Reuters Wealth and Kiplinger’s Personal Finance.