Socially Responsible Investing: Trends and ETF Track Records

When we first explored back in 2009 the idea of vetting investments based on ethical criteria, the ETFs created to implement the idea were relatively new and there was no real track record to say whether investment returns were the same, better, or worse than the broad market index funds. Was the idea just a fad that would pass in the face of other concerns like jobs and the economy after the 2008 credit crisis and its aftermath?

There is a collection of terms describing facets of the concern many people have - corporate social responsibility, ethics, governance, sustainable development, green or environmental responsibility. If we are to judge by how often these ideas receive mention in the worldwide press as tracked by Trends in Sustainability's Online Analysis Tool, which was used to generate the charts below, the multi-decade upwards trend of Sustainability suggests an important impetus for investors to consider.

Sustainability idea rising in importance for decades

Key sustainability issues - climate change (environmental), human rights (social), corruption (governance)

No big move to ESG/SRI as an investment trend for individuals
The explosion of ETFs in just about every direction has not yet reached the ESG/SRI slant. There is still only one Canadian ETF - the iShares Jantzi Social Index® Fund (TSX: XEN) - which five years after its launch has gathered a puny $17 million in assets. In the USA, there is only a handful of such ETFs (see ETFdb's screener result for SRI) with about $360 million in total assets, a small amount for the US market.

Apparently, institutional investors have been much more active in pursuing SRI investing according to this European report.

A high degree of overlap between ESG/SRI ETF holdings and non-SRI counterparts
Perhaps it is encouraging to know that the Jantzi index developers Sustainanalytics judge that so many large Canadian companies meet their SRI criteria. The result is that three quarters of XEN's holdings are also in the standard dominant cap-weighted Canadian equity ETF, the iShares S&P/TSX 60 Index Fund (TSX: XIU). XEN's holdings that are not part of XIU amount to only 2.67% of the fund's total assets.

The overlap between the US-oriented funds

• Pax MSCI North America ESG Index ETF (NYSE: NASI),  
• iShares MSCI USA ESG Select Social Index Fund  (NYSE: KLD) and
• iShares FTSE KLD 400 Social Index Fund (NYSE: DSI) 

is even higher at 80 to 85% with the iShares Core S&P 500 tracker (NYSE: IVV). In fact, the stocks the stocks are mostly deliberately chosen from amongst those in the mainstream large-cap US market index. The overlap is by design.
Result: a close tracking of the market performance of the mainstream ETFs by the ESG/SRI ETFs
The high degree of overlap seems to be more powerful in determining returns than the influence of stocks in the mainstream index that the ESG/SRI ETFs leave out. Indeed the KLD FactSheet explicitly says the aim is for the ETF to show the same risk and return characteristics as its mainstream kin.

Canada
XEN bounces along in close alignment with XIU as seen in this screen capture from BMO Investorline's ETF Compare Tool (available only to BMOIL's clients). Moreover, the annualized total return over the past five years is very close: XEN at -0.99% vs XIU's -0.40%. That is just about the difference between the XEN Management Expense Ratio (MER) at 0.55% and XIU's at 0.18%. The small annual difference adds up in the long run. Over five years, XEN's cumulative total return is -3.89% vs XIU's -2.37%

USA
KLD and DSI follows IVV quite closely. Even NASI, despite about 10% of its holdings being Canadian stocks, follows the IVV's contours, though its more recent startup produces the higher starting point of its line in the chart below. Higher MERs on the ESG/SRI funds at 0.50% likely account for most of the slight annualized under-performance. That annual difference has added up. Over the past 5 years, KLD returned 1.33%, DSI 1.91% while IVV returned 4.07%.

EAFE / Developed Countries
The same close tracking shows up with the Pax MSCI EAFE ESG Index ETF (NYSE: EAPS). Over the year since its launch it has earned 6.08% while the standard cap-weight equivalent Vanguard's MSCI EAFE ETF (NYSE: VEA) returned 5.67%. It remains to be seen whether more years under the belt will see VEA pull ahead - its MER is only 0.12% vs EAPS' higher 0.55%.

Bottom Line
The above returns results jive with the bulk of academic research, such as summarized in the 2007 paper Does Socially Responsible Investing Hurt Investment Returns? (answer = no) from Phillips, Hager and North or Meir Statman and Denys Glushkov's 2009 The Wages of Social Responsibility on Miller/Howard Investment Inc's website (answer = the advantage of picking stocks with high SRI scores is more or less offset by the disadvantage of SRI's shunning "bad" companies).

Such academic studies did not factor in costs, such as the MER. The biggest issue is the higher MERs at 0.5+% of the ESG/SRI funds while the mainstream broad market large cap funds have MERs of 0.1% or less. That seems to be creating longer-term rising cumulative under-performance. If so, whether SRI/ESG ETFs are worth it is an individual investor decision.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.