Socially Responsible ETFs: Look Under the Hood

June 18th at 3:00pm by Tom Lydon

A developing trend in the investment world has people aligning their personal philosophies with their pocketbooks. Exchange traded funds (ETFs) are looking to make that easier with socially responsible ETFs. But buyers beware – that doesn’t absolve you from looking under the hood.

Socially responsible ETFs are still only a small slice in the $3 trillion SRI arena, reports Sheryl Nance-Nash of Daily Finance. There’s about $3.2 billion invested across 24 socially responsible ETFs, which is a broad term used to describe funds that invest in companies that have strong corporate governance or are environmentally responsible. Some of these funds screen out companies involved in “sin” industries, such as gambling, drinking or tobacco.

Such ETFs are expected to grow in numbers and assets as interest in socially responsible investing continues to gain traction. Just last month, three new ETFs – ESG Shares North America Sustainability Index ETF (NASI), ESG Shares FTSE Environmental Technologies ETF (ETFY) and ESG Shares Europe Asia Pacific Sustainability Index ETF (EAPS) - were announced by Pax World. [All About the New Pax World ETFs.]

However, Sheryl warns that labels can be deceiving. One of the challenges that SRI ETFs face is that they are passive vehicles. According to one fund’s prospectus, companies are rated by standardized criteria for eligibility rather than active management.

iShares KLD Select Social Index Fund (NYSEArca: KLD), for example, holds 0.2% of Transocean (NYSE: RIG), which had the distinction of owning the drilling rig in the recent Gulf oil spill. “You have to ask yourself why Transocean would be in this portfolio because it’s an obvious infraction of clean technology,” says Jim Porter, managing member of Aston Asset Management.

What are the implications for investors? “Investors should research and fully understand not only the ETF they’re considering for investment, but also the underlying index that the product is tracking,” says Kevin Mahn, portfolio manager of SmartGrowth Funds. [Solar ETFs: Is Now the Time?]

“If an ETF holds only one or two questionable positions… [and] that exposure is one-tenth of 1%… it probably doesn’t make sense to divest for that reason, unless it causes a serious doubt of judgment or investment practices of the entire management firm,” says Gay, CEO of First Affirmative Financial Network. [Knowing the Holdings of Your ETFs.]

Porter says, “If it’s no longer aligned with your values, especially because you sometimes pay more for a socially responsible investment, and if you aren’t getting great returns, as some SRI ETFs have underperformed the S&P 500, then walk away.” [Having a Strategy.]

For more stories on ETFs, visit our ETF 101 category.

Sumin Kim contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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