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 young 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 to focus their investments.
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 in their 20s and 30s are now 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 2017, there were 234 ETFs and mutual funds that purported to invest in companies that were screened for factors related to socially responsible investment principles such as environmental and social impact. The report suggests that the number of such funds has more than doubled since 2012 and that the assets in those funds have risen by 142% in the intervening time. By the start of 2018, SRI ETFs and mutual funds were an industry accounting for more than $100 billion in assets.
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, adding 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 one will find Apple Inc. (AAPL) but not oil driller Transocean Ltd. (RIG), for instance.
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 Facebook, Inc. (FB), and The Walt Disney Company (DIS).
The Bottom Line
While it may be tempting to look at ETFs that focus specifically on one area of interest in the socially responsible investing world, Dave 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.