Just over a year ago I started what I thought was a simple idea, to put together some low-cost ethical investment portfolios, readily available online for anyone to invest in. As my focus was low-cost, I thought the best products would come from the wide range of ethical exchange-traded funds (ETFs). By my reckoning there are close to 100 such ETFs globally to choose from, more than enough to construct some well-diversified investment portfolios.
What I discovered in this search is that there are, on the one hand, some great, innovative products available. On the other hand, there are some that are ethical in name only. For me, the due diligence process was a lot more interesting than I expected, and I have shared some of my insights below.
Highlights of the good points
Let’s start with the good stuff. In recent years there’s been a large increase in the range of ethical ETFs on offer. Of the ones we reviewed, over 25% were created in the past year. This has led to the launch of some specific innovative products, enabling investors to tailor their portfolios to their unique values. These include:
- UN sustainable development goals: In September 2015 the United Nations set out 17 goals designed to transform the world. These include eradication of poverty, quality education, gender equality, clean energy, and many more. Blackrock have put together an ETF (ticker MPCT) where investors can access companies that generated at least 50% of their revenue from achieving one of these goals.
- Gender diversity: A number of studies have shown that companies with more women on the board perform better than their male-dominated counterparts. If you want to support gender diversity, State Street Global Advisors offer an ETF (ticker SHE) that invests in S&P500 companies based on the number of women on the board and in senior leadership positions.
- Organic food: If you love your organic produce and want to align your investments with your eating habits, you could try Janus Capital’s ETF (ticker ORGID). This ETF invests in global companies that service, produce, distribute or sell organic food, drinks, and cosmetics.
- LGBT rights: Workplace equality is a broader issue than just gender diversity. Denver Investments offers an ETF (ticker EQLT) that invests in US companies that support LGBT equality in the workplace, for example by offering benefits to same-sex couples.
Above is just a sample of some of the ETFs we came across that offer something more than just negative screens. There are also a wide range of ETFs available that do offer the negative screens, excluding tobacco, gambling, alcohol, pornography, and arms-related enterprises.
Highlights of the questionable points
‘Ethical’ is a widely-used term, open to interpretation by whomever is constructing the ETF, and this project has taught me there are uncertainties when selecting an ethical ETF investment.
Exchange Traded Notes
Barclays offers a variety of ethical Exchange Traded Notes (ETN), such as their Return on Disability ETN. One potential problem with this structure is that the ETN is an unsecured debt obligation of Barclays Bank. The return of the ETN is linked to the Disability US LargeCap ETN Total Return USD Index which tracks the performance of 100 stocks selected based on their support for people with disabilities. This index is managed by the Donovan Group (not Barclays). You need to ensure you are aligning your investments with your values, and accept this is providing funding for Barclays rather than an investment in the companies in the index.
Index providers use their own definitions that are not consistent among providers. Some examples include:
- Environmental, Social & Governance (ESG) criteria: One ESG ETF is not necessarily the same as another, it depends on the index provider’s ESG criteria. Even those that rely on the same criteria, such as a MSCI ESG rating, may apply it differently. For example, some ETFs only invest in companies with a minimum MSCI ESG Rating, others consider the rating but do not have a minimum threshold.
- Fossil fuel free: Fossil fuels are a particularly tricky area. Some indexes define a fossil fuel company as one that holds fossil fuel reserves, others only exclude those that produce ‘more carbon-intensive fossil fuels’, while others exclude companies with a ‘significant interest in’ fossil fuels. It is worth checking the fine print to make sure your fossil fuel free ETF is excluding the companies you want to divest from. MSCI has a guide about different approaches to divesting from fossil fuels, which you can find here.
- Emerging markets: Many index providers have a slightly different definition of emerging markets. If there are particular countries that you are looking to invest in, check that they are included in the definition.
UBS offers six ETFs with exposure to different regions, all of which exclude tobacco and controversial weapons (i.e. landmines, cluster bombs, chemical weapons). Yet two of these do not exclude any companies. In Australia, there are no tobacco or controversial weapons companies in the ASX100, so the UBS ETF is exactly the same as a mainstream investment. Similarly, in their Asia APEX 50 Ethical ETF, there are no tobacco or controversial weapons in the top 50 largest companies in Asia, so essentially you are investing in the MSCI Asia Apex 50.
There is nothing inherently wrong with these ETFs, they do follow the guidelines and none of the ETFs include tobacco or controversial weapons. However, while the product is true to the stated exclusions, they are somewhat redundant.
It is always worth looking at an ETF’s holdings if you’re considering an investment, and sometimes they may surprise you. For example:
- We came across a couple of ESG ETFs that include Wells Fargo. Apparently they have a very high ESG Score, however many people would expect the large-scale fraud that occurred at the bank to automatically exclude them from an ESG portfolio.
- The iShares MSCI Low Carbon Target Index has a 73% reduction in current carbon emission intensity and a 99% reduction in potential carbon emissions when compared to the MSCI All World Index. This is great, but it should not be confused with a fossil fuel free index as it does contain some oil companies (e.g. Exxon Mobil, Chevron, Caltex).
- An ETF that has a single focus (e.g. women on the board, or fossil fuel free) will invest purely based on that focus. Such an ETF could therefore contain companies involved in tobacco, gambling, or pornography. Don’t assume that because an ETF has a single ethical focus it excludes all non-ethical industries.
Emily Martin, CFA, is Chief Investment Officer at Balance Impact. The information in this article is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. A full list of ethical ETFs that were reviewed can be found in the ebook at www.balanceimpact.com.au/ebook.