Much has been said about the millennial generation's investment practices (or perhaps about the lack thereof). Suffice it to say, millennial investors often approach their financial decisions in a different way than generations before them. A once-standardized stock-and-bond portfolio is not necessarily an ideal approach for these younger investors. Rather, many millennials have shown a tendency to consider external factors, such as social causes and environmental impact, when choosing everything from investment strategies to specific companies in which they invest.
Socially responsible investments (SRIs) are an area of the financial world that is rapidly expanding. Indeed, a report by Morgan Stanley's Institute for Sustainable Investing, reported on by USA Today, suggests that Americans, now in their late 20s and early 40s, are twice as likely as the general investor population to focus on SRI investments.
Perhaps it was only a matter of time, then, before SRIs intersected with another branch of the investment universe that is also growing at a rapid clip. Exchange-traded funds (ETFs) are quickly becoming favorite investment vehicles for millennials as well as for investors of other generations. Now, investors looking to make a profit while making a positive difference in the world have a roster of hundreds of ETFs and mutual funds from which to choose.
The U.S. Department of Labor released a new regulation in late October 2020 that may limit or eliminate socially responsible investing in retirement plans. While the rule was revised to remove explicit references to environmental, social, and governance (ESG) factors, it mandates that fiduciaries of retirement plans choose investment strategies based entirely on how those strategies affect financial performance. This ruling may have a significant impact on funds and investments classified under ESG and socially responsible investing.
234 SRI Funds
According to fund-tracker Morningstar, by the end of 2021, there were 534 ETFs and mutual funds that purported to invest in companies that were screened for factors related to socially responsible investment (SRI) principles, such as environmental and social impact. The report suggests that the number of such funds is up 36% since 2021, and that 26 existing funds adopted sustainable mandates in 2021. Assets in those funds reported a record $357 billion in 2021, more than four times the total in 2018.
Head of responsible investing at PNC Asset Management Group, David Alt, CFA, CFP, suggests that the rise in sustainable ETFs is closely linked to the dramatic growth in the ETF field more broadly. "All investors are embracing passive ETFs ,due to their low cost and daily transparency," he indicates. He adds that "sustainable ETFs that are broad enough to resemble a fully diversified index have similar features as traditional passive ETFs," including "access to investment strategies in a low-cost manner."
Areas of Focus
What makes an ETF part of a socially responsible or sustainable investment portfolio? For Wealthsimple, a Toronto-based online investment management service, there is a rigorous test. Co-founder Michael Katchen indicates that "the assets that go into the socially responsible portfolios have gone through a screening process to make sure they meet the requirements of a particular fund."
The iShares MSCI ACWI Low Carbon Target ETF (CRBN) is one particular sustainable ETF that focuses on companies with an interest in low-carbon emissions, offering access to a basket of stocks from around the world that reflect this goal. Companies in this basket are less dependent on fossil fuels than their peers, meaning that there will be Apple Inc. (AAPL), for instance, but not oil driller Transocean Ltd. (RIG).
Another area of focus common in the sustainable ETF world is affordable housing. The iShares GNMA Bond ETF (GNMA) offers investors a chance to "promote affordable housing" through investments in residential mortgage-backed bonds issued by the U.S. government.
For those investors looking to focus on companies with a commitment to gender diversity and equity, there are ETFs like the SPDR SSGA Gender Diversity Index ETF (SHE). Companies represented in this ETF's holdings may have a greater number of women on the board of directors than their peers. The ETF focuses on companies that are "leaders in advancing women through gender diversity," according to the fund's summary prospectus.
Many millennial investors, in particular, are interested in local initiatives. In this case, an ETF like the Invesco Taxable Municipal Bond Portfolio ETF (BAB) is a popular choice. This fund allows investors to assist in funding environmentally friendly projects, while also managing risk through bonds issued by local municipalities.
It's also common for SRI ETFs to focus on so-called socially responsible issues. MSCI calls this set of stocks those with "positive environmental, social, and governance characteristics." The iShares MSCI KLD 400 Social ETF (DSI) offers exposure to a swath of companies that are not involved with alcohol, tobacco, gambling, military weapons, adult entertainment, and other flagged areas. Investors holding this ETF will instead have exposure to companies like Meta Platforms Inc. (META), formerly Facebook Inc., and The Walt Disney Company (DIS).
What is an ETF?
An ETF is an exchange-traded fund, which is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other asset, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.
What is a socially responsible investing (SRI)?
A socially responsible investing (SRI), also known as social investment, is an investment that is considered socially responsible due to the nature of the business the company conducts. A common theme for socially responsible investments is socially conscious investing. Socially responsible investments can be made into individual companies with good social value, or through a socially conscious mutual fund or exchange-traded fund (ETF).
What is ESG criteria?
Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
Who are the millennials?
The millennials are a cohort born between the years of 1981 to 1996, who are now between the ages of 26 and 41.
What is a prospectus?
A prospectus is a formal document that is required by and filed with the Securities and Exchange Commission (SEC) that provides details about an investment offering to the public. A prospectus is filed for offerings of stocks, bonds, and mutual funds. The prospectus can help investors make more informed investment decisions because it contains a host of relevant information about the investment or security.
The Bottom Line
While it may be tempting to look at ETFs that zero in on one area of interest in the socially responsible investing world, PNC's Alt recommends caution when dealing with these funds. He says that "the issue with thematic ETFs that are specific to one theme or strategy is that they often come with much higher fees than traditional passive strategies, even though those strategies are also passive. You're oftentimes paying active manager fees for a passive strategy. You also need to look at the underlying securities in a thematic ETF."
One important takeaway is that investors interested in SRI ETFs must still do their research; Alt suggests that an ETF "might be marketed as following a specific theme like 'water,' but investors need to look at the underlying stocks to determine if the companies have a sufficient exposure to water projects." Beyond that, "investors should always look at the underlying holdings and expenses as part of the process to determine if a sustainable ETF or a thematic strategy is a prudent investment," Alt suggests.