Updated: Jun 26
“They say you cannot have your cake and eat it too…but ain’t that what ya supposed to do?” (Anonymous)
A number of my clients with disabilities as well as their family members and friends are drawn to what is called Socially Responsible investments (SRI) or Environmental/Sustainability/Governance (ESG) investments. They have seen so many examples of systems and practices gone wrong that they want to use their investment dollars to do right. At the same time, they often need to hit certain very practical financial goals, and they are concerned that, as conventional wisdom used to have it, SRI or ESG-screened investments will underperform the general market. Finally, they are confused as to the proliferation of funds with various labels: Green, Environmentally Friendly, Socially Conscious, Impact or Ethical investing, or as generally “Faith-Based” or as specifically “Catholic”, “Mennonite”, “Halal”, or any other religious tradition or philosophy. This blog considers only mutual funds, index funds, and exchange-traded funds. It is also possible to evaluate individual companies on their Environmental/Sustainability/Governance and Socially Responsible policies and practices.
Frankly, the jury is still out on performance. Some reports claim that screened investments do underperform the larger market and attribute this to the reduced diversity that comes from screening out certain companies. Other reports claim that screened investments actually outperform the broader market and attribute this to better management and practices as well as to more aware and responsive corporate leadership. What is unarguable is that the breadth and depth of investments broadly categorized as SRI or ESG have increased markedly over the past two decades. The expense of managing an investment vehicle clearly reduces that vehicle’s returns; and, as the nay-sayers suggest, more diverse investments perform better than less diverse ones over the long term. The rise of SRI/ESG index mutual funds and exchange traded funds with expense ratios below 30 basis points (0.3%) means that there are options to invest in line with one’s values without sacrificing investment potential to cost or lack of diversity. As for the variety of investment approaches, it is important to understand the goals and approaches of different types of ESG/SRI investments in order to pick the investments that best match your own objectives. Broadly speaking, there are two approaches to ESG/SRI. (photo by Pratiksha Mohanty via Unsplash).
One approach to ESG/SRI investing is “values driven”. Some mutual or exchanges-traded funds screen their component investments to fit a well-defined sector or objective. For example, the iShares Global Clean Energy ETF (ICLF) only invests in companies that are actively involved in biofuels and ethanol along with geothermal, hydroelectric, solar, and wind power. In addition, the fund also invests in companies that develop technology and build equipment for the production companies. The SPDR SSGA Gender Diversity Index Fund (SHE) comprises US large-cap companies that have a relatively high proportion of women in management. The US Vegan Climate ETF (VEGN) excludes companies with businesses that either use animal testing or use animals for sport or entertainment, and excludes companies that harm the planet by extracting, refining or promoting the use of carbon-intensive fuels, and companies that produce weapons or substances that are harmful to people.
Then, there are funds such as the S&P 500 Catholic Value Fund (CATH), which screens out S&P 500 companies, engaged in unconventional weapons, contraception, abortion, stem-cell research, and pornography production as well as other businesses contrary to Catholic values. The Inspire 100 ETF (BIBL) excludes stocks with any degree of participation in activities such as abortion, gambling, alcohol, tobacco, pornography, the LGBT lifestyle (this does not reflect the blog author’s own values), or rights violations, deemed contrary to the managers’ definition of Biblical values. The Wahed FTSE USA Shariah ETF (HLAL) invests in US large and mid-cap companies, deemed to be consistent with Muslim values and excludes those involved in conventional finance, alcohol production or the sale of pork-related products or non-halal food related businesses, casino management, adult entertainment, tobacco production/sales, and weapons-related businesses. The Six Thirteen Core Equity Fund (TZDKX), originally launched to provide a Jewish values investment vehicle, but has subsequently closed.
It is entirely legitimate to choose one of these funds because you want to support renewable energy or fair trade or because you want to reduce reliance on fossil fuels or because you want to make sure that the companies you invest in do not violate a tenet of your faith. But it is also important to recognize that the funds that either focus on one or a few sectors or screen out one or more entire sectors are “niche funds”. If you want or need your portfolio to benefit from the growth potential of the overall market, these niche funds should be used to compliment the core of your portfolio, rather than to build it.
The second approach to ESG/SRI investing is data driven. Morgan Stanley Capital International, commonly abbreviated as “MSCI”, is a company that creates and maintains indices, and these indices are frequently used as the basis for Exchange Traded Funds. MSCI has a robust suite of ESG screens, and the company rates other companies on the ESG policies and practices on a scale that ranges from AAA (excellent) to C (poor). Thompson Reuters scores companies from A+ (excellent) to D- (poor). Morningstar has a five-globe system (analogous to its five-star ratings for non-screened investment quality) for rating funds on sustainability. Each rating agency evaluates investments across a wide range of environmental, sustainability, and governance criteria without either targeting or excluding particular industries. Certain ESG investments are built by taking all the companies in a particular market-cap class or geographical sector that have ESG scores above a certain threshold. These funds are, therefore, much broader and diverse, and are more likely than values-driven funds to track the broader market’s performance. Examples of data-driven funds include the iShares ESG MSCI EAFE ETF (ESGD), the Nuveen ESC Large-cap ETF (NULC), and the Columbia Sustainable International Equity ETF.
Using money according to one’s values has a long and rich history dating back even centuries before the common era to Biblical times. Exodus 22:25-27 compels a lender to return the borrowers cloak (pledged as collateral) before nightfall and Deuteronomy 24 insists that farmers leave some grain unharvested to be gleaned by those in need. The Rig Veda (1700-1100 BCE) and the Sigalovada Sutra (600-400 BCE) both connect wealth to righteous living. The Qur’an (609-632 CE) stipulates terms for just lending and prohibits usery. More recently, the Methodists and the Quakers expected members to refuse to benefit from the slave trade, and in modern times, investors have used divestment to pressure the South African and other governments to changes. With the proliferation of SRI/ESG investment vehicles, you have more opportunities than every to do well while doing good—to have your cake and eat it, too.