Socially responsible investing was once widely considered an offbeat niche, for hardcore environmentalists rather than serious investors. To some critics, SRI was practically socialism, an attack on the invisible hand of self-interest that was supposed to drive a capitalist economy.
But not now. SRI now accounts for one about one in every six pooled investing dollars in the U.S., or nearly $6.6 trillion at the start of 2014, according to the biennial report of the Forum for Sustainable and Responsible Investment. Investment pools using SRI principles (also called environmental, social and governance, or ESG investing, or, simply, ” sustainable investing“) grew from 55 in 1995 to 925 in 2014, the report said.
Some funds shun the defense or fossil fuels industries, others stay away from gun makers, alcohol or tobacco producers, or companies deemed unfriendly to their workers, shareholders or the environment. Whatever your chief social, economic or religious concern, there’s probably a fund for you.
[See: 7 of the Best Socially Responsible Funds.]
And now there are growing opportunities for SRI investing through exchange-traded funds.
“ETFs are a valuable tool for helping to improve risk-adjusted returns over the long term, and this characteristic is particularly important for investors focused on socially responsible strategies,” says Tom Lydon, president of Global Trends Investments in Irvine, California.
“That’s precisely why more and more firms are offering ETFs that target companies that adhere to economic, social and governance principles. It gives investors an option not only to be socially responsible in their investments, but also to improve the long-term outlook for their portfolios.”
Lloyd Kurtz, head of social impact investing at Wells Fargo Private Bank, expects this sector to continue growing, largely due to interest from women and millennials. “They don’t see their investment portfolios existing in a vacuum, and want them to reflect their view of the world and the future,” he says.
Morningstar lists more than 100 funds using SRI principles.
Although individual investors have been gradually embracing sustainable strategies, the bulk of investment comes from institutional investors like college endowments responding to students, alumni and faculty urgings; and pension funds, reacting to participants who care about worker issues such as wages and benefits, or use of sweat shops.
Especially popular these days, according to industry insiders, are funds seeking investments that address global warming.
Years ago many investors and experts assumed that inserting personal values into investment decisions would damage returns. But now that the sector has matured, there’s data to the contrary. A 2015 report by Morgan Stanley found that “investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments. This is on both an absolute and a risk-adjusted basis, across asset classes and over time.”
Advocates typically attribute the performance to better governance practices and less profit-eroding conflict with workers, regulators and consumers. Some of the popular screening criteria include an absence of poison-pill anti-takeover provisions, transparency about executive pay and policies deemed to favor shareholders’ rights.
“SRI/ESG funds do well for the same reasons other investment strategies do well: good diversification, good asset selection, and good risk management,” Kurtz says.
ETFs make this kind of investing easy, offering the same low fees and tax efficiency investors have become accustomed to with other ETFs, and making access to ESG strategies easy for small investors.
“We view ETFs as a way for investors to better access and implement ESG investment themes in a much more timely and transparent manner, with greater market efficiency and daily liquidity,” says Bob Smith, president and CIO of Sage Advisory Services, an asset management firm based in Austin, Texas. “ETFs provide a better gateway for both large and small investors to become more involved with ESG considerations at a pace, level, scale and orientation that is individually suitable.”
[See: 10 Energy ETFs That Will Clear Your Conscience.]
But if the goal is to have real impact, are ETFs the best way to go?
Some advisors say no, because the fire-and-forget index-style investing is too much of a blunt instrument, while teams running actively managed funds can pick and choose holdings for the most impact.
“As far as ETFs go, the universe isn’t nearly as broad as one might believe,” says Chris Georgandellis, founder of Tree Town Investments, an advisory firm in Ann Arbor, Michigan, that specializes in socially conscious investing.
He argues that many SRI ETFs are similar because, as passively managed funds, they have little choice but to tie themselves to one of the two main social investing indices: first, the MSCI KLD 400, which draws stocks from the MSCI USA Index of large and mid-capitalization U.S. companies, then screens out firms involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, genetically modified organisms and adult entertainment. The second index, the MSCI ESG index selects stocks with high ESG marks taken from the MSCI World index, which consists of large and mid-cap companies in 23 developed countries.
“An examination of any of these reveals a tremendous amount of overlap — not just between the two indices, but between those indices and the S&P 500,” Georgandellis says. He says the most popular ETFs using these indexes are iShares MSCI USA ESG Select (Ticker: KLD), iShares MSCI KLD 400 Social ( DSI) and iShares MSCI EAFE Optimized ( ESGD)
“You would be hard-pressed, in my opinion, to construct a well-diversified portfolio using only one or two of these indices,” he says, arguing that most investors “would be better off investing in one of the myriad of actively managed ESG mutual funds, or hiring a dedicated asset manager to invest their funds in individual stocks.”
Of course, those options involves higher fees.
But he notes that investors motivated by principles can live with that: “It’s hard to put a monetary value on the feeling that an investor gets knowing that he or she has made socially responsible choices in their investment portfolios, and it’s beyond difficult to measure the direct impact that many small, retail investments in ESG-type investments have on the corporate governance landscape.”
An investor can also use the holdings of the ESG indexes, or big funds tracking them, as a guide to individual stocks meeting specific criteria, thus avoiding the higher fees charged by actively managed funds and the imprecision of the index products.
Many investors turn to advisors skilled in this area, says Debashis Chowdhury, president of Canterbury Consulting, an investment consulting firm in Newport Beach, California.
[Read: 4 Passive Investments Millennials Can Use to Fund Their Retirement.]
“While there are many providers of index and fund products who provide their own form of pre-screened portfolios, our clients prefer a customized solution that is precisely tailored to their specific mission and values,” he says.
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