In recent years, issuers of exchange-traded funds (ETFs) have brought an increasing number of funds dedicated to environmental, social and governance (ESG) principals to market. However, the concept of ESG investing traits in the ETF wrapper is not new. For example, the iShares MSCI KLD 400 Social ETF (DSI), home to more than $1 billion in net assets, turned 11-years old in November. DSI tracks the MSCI KLD 400 Social Index, which is "composed of U.S. companies that have positive environmental, social and governance characteristics as identified by the index provider," according to iShares.
This ESG ETF holds 405 stocks, indicating that is a different animal than the S&P 500. A familiar argument as it pertains to ESG investing is whether or not principal-based investing can generate superior outcomes for investors. (See also: 3 Trends to Watch in ESG Investing.)
The idea of investing based on principals is undoubtedly attractive to many investors, but the name of the investing game is to make money. For ESG ETFs to continue flourishing, these funds need to deliver returns that are at least in the ballpark of non-ESG benchmarks with comparable or lower risk. Past performance is never a guarantee of future returns, but DSI's lengthy track record at least gives investors a sense for how prioritizing ESG traits can affect total returns.
DSI debuted in mid-November 2006 and has returned 7.71% since inception.
ESG strategies often overweight technology stocks and underweight energy relative to the S&P 500, and DSI is true to that form. DSI allocates 29.7% of its weight to technology. SPY allocates less, with 22.6% of their assets in the technology sector. DSI's energy weight of about 4.5% is smaller than the S&P 500, which has an energy weight of 5.84%. DSI is also underweight in financial services by more than 5% against the S&P 500. Noting that DSI is underweight in energy and financial services, two of this year's worst-performing sectors, while being overweight in technology, the top-performing sector, it can be argued that the ESG fund should be doing more than merely keeping pace with broader U.S. equity benchmarks.
One glaring reason DSI is not outperforming the S&P 500 is that the ESG ETF, despite being overweight technology, does not own shares of Apple Inc. (AAPL). The tech monster was up considerably for most part of last year.