Innovation remains a driving force in the ETF universe and the increasingly diverse product lineup is evidence of this phenomenon. Socially responsible investing is by no means a new concept as mutual funds have been employing “sustainable” investing strategies for years now; however, the introduction of this investment approach in an ETF wrapper has made the strategy easy-to-use and cost-effective, thereby inevitably attracting attention from mainstream investors [see 101 ETF Lessons Every Financial Advisor Should Learn].
Socially Responsible ETFs Performance Check
The unifying factor across all “socially responsible” investing strategies is identifying companies deemed to have positive environmental, social and governance (“ESG”) factors. While this style is certainly appealing for a variety of moral reasons, socially responsible investing also boasts performance merits as there is a fair amount of evidence that suggests that stocks with higher ESG scores tend to outperform the broad market over the long haul [see Socially Responsible ETFdb Portfolio].
What many investors don’t realize is that socially responsible investing does not limit your scope to green energy and organic food companies; in fact, many would be surprised to learn that the top holdings among Socially Responsible ETFs include well-known corporate giants, such as Procter & Gamble (PG) and IBM (IBM). As such, socially responsible ETFs feature risk-return profiles that are surprisingly similar to those of popular broad-based, passive index funds given their overlap in underlying holdings.
While the various Socially Responsible ETFs out there are constructed with similar methodologies in mind, they are far from identical. In fact, the differences from one Socially Responsible ETF to the next can be significant, and these seemingly trivial nuances have a meaningful impact on returns [see Free ETF Head-To-Head Comparison Tool].
The chart below illustrates the differences among risk/return profiles between the biggest Socially Responsible ETFs as compared to the broad stock market, represented by SPDR S&P 500 (SPY, A). Note that the risk/return profile is defined by a fund’s 200-day volatility and trailing one-year return, while the respective annual dividend yield of each ETF is represented by the size of each bubble:
- iShares KLD 400 Social Index Fund (DSI, B)
- iShares KLD Select Social Index Fund (KLD, B-)
- Pax MSCI EAFE ESG Index ETF (EAPS, C+)
- Pax MSCI North America ESG Index ETF (NASI, n/a)
Keep in mind that the above chart is based on trailing returns, and as such, its composition will likely change over time. There’s no universally right choice from the above ETFs; for some, a higher-yielding ETF like EAPS makes sense, while others may be in search of a less-volatile offering like DSI. The takeaway here is to remember to take a good look under the hood before pulling the buy trigger as each product features a host of unique advantages and drawbacks.
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Disclosure: No positions at time of writing.