Socially responsible ETF – Should you invest?
The Socially Responsible ETF is here! What is socially responsible investing anyway? Why would you want to invest? And why wouldn’t you want to invest?
Global warming, sweatshops, dangerous substances, weapons, gambling, pornography, booze, cigarettes, exploitation, pollution, animal cruelty and corruption! You name it people invest in it. Some people don’t know they invest in this stuff. Others just don’t care.
But what if you do care? What if you feel strongly about the world in which we live? Can you still invest and be able to sleep at night?
The good!
Perhaps you can. Socially responsible investing (SRI) is here. Now you can choose to invest in funds that choose companies that are socially responsible. Even better you don’t need to pay crazy money for a money manager because you can invest in a socially responsible ETF yourself.
A socially responsible ETF skips the bad guys and concentrates on the good guys. Of course, who the good and bad guys are will depend on you.
Some people don’t mind alcohol companies, but would draw the line at cigarettes. Others don’t mind either of the above, but would draw the line at weapons. What ever your flavor, there is likely to be a product suitable for you.
It turns out these funds aren’t hard to find. A quick search for SRI on Morningstar brought up a list of 25. Morningstar even provides a detailed sustainability rating for their funds.
Morningstar ratings
In order for a fund to receive sustainability data, the fund needs Sustainalytics Environmental, Social and Governance research on at least 67% of assets. The ratings are scored in five grades. These are, High, Above Average, Average, Below Average, and low. You can see a rating below.
Funds that don’t claim to be socially responsible are still scored. For example Vanguard FTSE All-World UCITS ETF achieves 2 globes or a below average rank.
The 25 socially responsible ETFs contained products from 3 companies.
First of all there are 7 from UBS including the MSCI United Kingdom IMI Socially Responsible UCITS ETF which focuses on large UK companies.
Morningstar describe the funds objective as follows:
The objective of the Fund is to seek to track the performance of United Kingdom based companies which focus on Environmental, Social and Governance (“ESG”) considerations and which would specifically exclude companies involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms and genetically modified organisms.
Morningstar
This socially responsible ETF focused on the UK receives five globes, which is impressive as only 10% of funds achieve a high rating.
A quick look under the hood shows the top 10 companies in the fund are:
Rio Tinto, BP, GSK, Astra Zeneca, Unilever, Prudential, Reckitt Benckiser Group, Vodafone, RELX and National Grid.
You may notice the UKs three biggest companies HSBC, Royal Dutch Shell and BP are all missing. Omitting oil companies seems an obvious choice but how about HSBC? Well, by coincidence on the day I am writing this article the Telegraph has an article about HSBC (I think the title says it all!):
HSBC rejects calls to end pension cuts and fossil fuel funding
As well as the UBS funds there’s the Franklin LibertyQ Global Equity SRI UCITS ETF with ongoing charges of 0.4% and then the rest are from iShares, and there are a lot of them.
Many of these funds are specialized in particular areas or sectors. I’m sure it goes without saying that it probably wouldn’t be wise to add too much of one of these funds to your portfolio. That’s because concentration adds risk.
That said, if you want your entire portfolio to be socially responsible you can invest in a socially responsible ETF that covers the world.
For example, the iShares MSCI World SRI UCITS ETF also receives five globes and has ongoing charges of 0.3%.
iShares UK
Taking it a step further by going to iShares UK and searching for SRI reveals 41 funds. Though only about a third of them are strictly described as a socially responsible ETF, they are at least related with descriptions like sustainability, clean energy, Islamic, Environment, Social and Governance (ESG), inclusion and diversity.
Some of the most noticeable names on the list are:
- iShares Thomson Reuters Inclusion and Diversity UCITS ETF
- iShares MSCI USA Islamic UCITS ETF
- iShares Global Clean Energy UCITS ETF
These funds have ongoing charges of 0.25%, 0.50%, and 0.65% respectively so not overly expensive. The cheapest fund on the list is iShares MSCI USA ESG Screened UCITS ETF which comes with ongoing expenses of just 0.07%.
An alternative to the iShares MSCI World SRI UCITS ETF described above is the iShares MSCI World ESG Screened UCITS ETF. This fund has a cheaper ongoing expense of 0.20%.
It is not strictly described as a socially responsible ETF, but I’m sure it will satisfy the requirements of some investors. iShares describe the fund as follows:
WHY SDWD?
Broad exposure to a wide range of global companies within 23 developed countries.
Screens out exposure to thermal coal, weapons, tobacco, and other controversial industries.
Invest with purpose. Take a sustainable approach to pursuing growth.INVESTMENT OBJECTIVE
iShares
The fund seeks to track the performance of an index composed of developed market companies screened for exposure to thermal coal, controversial weapons, tobacco, and other controversial industries.
A quick look under the hood of this fund reveals the following top 10 companies: Apple, Microsoft, Amazon, Facebook, Alphabet, Johnson & Johnson, JP Morgan Chase, Exxon Mobil and Nestle.
And the top five sectors are Financial Services 18.3%, Consumer Cyclical 15.4%, Consumer Defensive 14.18%, Healthcare 11.5% and Basic Materials 11.42%.
Responsible investing – the bad!
All good so far but how about the drawbacks?
First of all some of this is going to be down to self governing, and whereas the guys at the top may be taking it seriously, it is not guaranteed that the importance of all this filters down throughout the company.
Socially responsible investing is definitely backed by good moral standing. However, the companies you invest in might not be completely socially responsible throughout their organization. As with anything in life there are likely to be incentives to fudge numbers somewhere down the line.
On top of that, it is worth considering the financial implications of this type of investing. If investing in a socially responsible ETF provided equivalent returns to investing in other ETFs then there wouldn’t be a decision to make.
In fact, if this was the case and fees were reasonable you’d probably find everybody investing them. Quite simply, there would be no reason not to.
Warning sign
The fact is they don’t. Unfortunately, socially responsible investing might come at a price. There are a lot of articles out there which mention the Credit Suisse Global Investment Returns Yearbook 2015.
In that yearbook esteemed finance professors Elroy Dimson, Paul March and Mike Staunton devote an entire section to comparing SRI investing with non-SRI investing.
Firstly, they compare the returns of two US mutual funds launched in the early 2000s. The Vice Fund is pitched up against the Vanguard FTSE Social Index Fund.
As the name suggests the Vice Fund is focused on companies that many would consider anything but socially responsible. These include tobacco, alcohol, gaming, defense and aerospace.
On the other hand the Social Index Fund invests in an index which screens for social, human rights and environmental criteria.
1-0 to irresponsible investing
The results didn’t make enjoyable reading for socially responsible investors. The Vice fund turned $10,000 into $33,655 while the Social Index Fund turned $10,000 into $26,788 over the same period.
However, as the comparison was made between 2002 and 2014, I took a look at the recent performance of the two funds and found something a little different. Between 2009 and 2019 the fortunes of the two funds reversed.
The Vice fund turned $10,000 into $30,602, whereas the Social Index Fund turned into $43,536. The results can be seen below. The Vice Fund is represented by portfolio 1 (blue).
There could be a number of reasons for this. First and foremost, is reversion to the mean, whereby stocks that outperform over one time period tend to underperform over the next and vice versa.
It’s not beyond the realms of possibility that once the fact that vice outperformed social responsibility became known everybody rushed to invest in vice and thus pushed the prices up.
Tobacco vs everyone else
The Credit Suisse team didn’t just look at these two funds, though. They also compared the returns of tobacco companies against the overall markets in both the UK and US. The US comparison was made over 115 years. The UK comparison was made over 85 years.
In the US Tobacco companies beat the wider market by 4.5% and in the UK by 2.6%. That is a pretty big outperformance particularly in the US. In fact, 4.5% outperformance is the kind of numbers hedge funds can only dream about!
There’s no argument that about the performance of tobacco compared to the wider market over the long term but what about more recently.
In the absence of a tobacco fund I compared British American Tobacco PLC against the FTSE100 over the past 10 years. The returns were 11.2% for British American compared to 10.3% for the FTSE100. The dark side is still ahead but only slightly in this instance!
Avoiding corruption
Finally the Credit Suisse team compared countries. They divided them up into four categories based on the control of corruption rating given by the World Bank.
The categories were poor, acceptable, good and excellent. The returns were poor (11%), acceptable (7.7%), good (5.3%) and excellent (7.4%).
So countries with poor corruption performance achieved the highest investment returns. Go figure!
This study is one that isn’t easy for somebody without the data (i.e. me) to have a look at what’s been happening recently. It may have reversed, but it may not.
Even though their study of Vice vs the Social Index does seems to have reversed in recent times, I still think the work that Dimson and the team carried out does raise the possibility that non-socially responsible companies may out perform socially responsible companies.
Why a socially responsible fund might underperform
And if that is the case, the question then has to be why? At the time of their studies Dimson and the team said this:
Much of the evidence that we review suggests that, as illustrated by the Vice Fund, “sin” pays. Investments in unethical stocks, industries and countries have tended to outperform. For those for whom principles have a price, it is important to know the likely impact screening may have on both performance and diversification. Also, ironically, responsible investors should recognize that they may be partly responsible for the higher returns from sin.
Elroy Dimson, Paul March and Mike Staunton
It is interesting that they think responsible investors maybe partly responsible. I think their argument comes down to the fact, that by choosing to invest in socially responsible companies investors inadvertently push up the prices of the shares of those companies.
At the same time, by deliberately avoiding socially irresponsible companies those same investors inadvertently lower the prices of shares in those companies. Being able to buy shares in companies cheaply, usually means improved longer-term returns.
You are left with socially responsible companies that are overvalued and socially irresponsible companies that are undervalued. You can buy the bad companies cheap, but you need to overpay for the good companies!
Why a socially responsible fund might outperform
Of course many socially responsible investors would put forward another argument. Many invest with the idea that by not investing in companies with questionable ethics they can reduce the flows of money to those companies.
The theory goes that doing so will reduce a companies ability to raise capital and in turn make it difficult for that company to do business. Unfortunately, there is little evidence of this.
Perhaps because not every company needs to borrow tonnes of cash to do business. Some companies can operate with next to no debt.
If that is the case, the company still has money to pay its dividend but at a reduced share price because socially responsible investors are shunning the shares. The end result is a higher dividend for those who do invest.
Taking action
Whether socially responsible investing out performs or not, there is an argument that this type of investor would be best served by investing in socially irresponsible companies and then clubbing together with other shareholders to put pressure on management to become more responsible.
At the end of a day when you invest in a company you become a shareholder. Shareholders in numbers have a voice and that voice can be used to force management into making changes, which if desired, could include improving social responsibility.
If investors really do place a premium for socially responsible companies, turning a not so socially responsible company into one that is socially responsible may just increase the share price.
I’m pretty sure most investors won’t be willing or have the ability to do that though, which brings us back to a socially responsible ETF.
Without doubt a socially responsible ETF has to be a good thing overall.
However, if you decide to invest in one, just know that by choosing to invest in some companies over others you may influence your investment returns.
The influence could be positive, but it could also be negative.
