The Rise of the Socially Responsible ETFs (2024)

Much has been said about the millennial generation’s investment practices (or perhaps 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 the 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 investing (SRI) is a rapidly expanding realm in the financial world. Indeed, results of a 2021 survey by investment firm Natixis showed that millennial Americans, now in their late 20s through early 40s, are twice as likely as the general investor population to focus on socially responsible investments.

Perhaps it was only a matter of time, then, before SRI intersected with another branch of the investment universe that is growing rapidly. Exchange-traded funds (ETFs) are quickly becoming favored 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.

Key Takeaways

  • Socially responsible investing (SRI) is increasingly popular, particularly among younger people, as investors aim to build portfolios that reflect their values.
  • A growing number of exchange-traded funds (ETFs) and mutual funds invest in companies that have been screened according to SRI principles.
  • Investors in SRI funds should be aware of potentially higher fees and ensure that the underlying holdings align with their overall goals.

More than 500 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 screened for factors related to SRI principles, such as environmental and social impact. The report said there were three times the number of such funds since five years earlier, and that 26 existing funds adopted sustainable mandates in 2021. Assets in the SRI-focused funds were reported at a record level of more than $350 billion in 2021, with net assets increasing 3.5 times since 2018.

The head of responsible investing at PNC Asset Management Group, David Alt, suggested that the rise in sustainable ETFs is closely linked to the dramatic, broader growth in the ETF field. “All investors are embracing passive ETFs due to their low cost and daily transparency,” he said. He added 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.”

The U.S. Department of Labor in October 2021 proposed regulation that may require fiduciaries managing investments to consider the economic effects of climate change and other environmental, social, and governance (ESG) factors when making investment decisions for clients and exercising proxy voting and other shareholder rights. The proposal also states that fiduciaries must consider ESG issues when material to an investment’s risk-return profile.

Areas of Focus for SRI Funds

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 said in an interview with USA Today 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), started in December 2014, is a sustainable ETF that focuses on companies with an interest in lowering carbon emissions. It offersaccess to a basket of stocks from around the world that reflect this goal. Companies in this fund are less dependent on fossil fuels than their peers, meaning that the ETF is more likely to hold, for instance, Apple Inc. (AAPL) and other technology or healthcare stocks that are low carbon emitters than a company like oil driller TransoceanLtd. (RIG).

Another area of focus common in the sustainable ETF world is affordable housing. The iShares GNMA Bond ETF (GNMA), for one, offers investors a chance to promote affordable housing through investments in residential mortgage-backed bonds guaranteed by the U.S. government.

For investors looking to focus on companies with a commitment to gender diversity and equity, there are ETFs such as the SPDR MSCI USA Gender Diversity ETF (SHE). Companies represented in this ETF’s holdings may have a greater number of women on their boards of directors than their peers. It focuses on companies “exhibiting certain gender diversity and diversity management characteristics,” according to the fund’ssummary prospectus.

Many millennial investors, in particular, are also interested in local initiatives. In this case, an ETF like the Invesco Taxable Municipal Bond ETF (BAB) could be a popular choice. This fund allows investors to indirectly assist in funding environmentally friendly projects while also managing risk by tracking bonds issued by local municipalities.

It’s also common for SRI ETFs to focus on the types of social issues for which they are named. Investment research firm MSCI calls this set of stocks those with “positive environmental, social, and governance characteristics.” The iShares MSCI KLD 400 Social ETF (DSI) tracks a swath of companies not involved with alcohol, tobacco, gambling, military weapons, adult entertainment, and other flagged areas. Investors holding shares of this ETF will instead have exposure to the stock performance of companies such as Microsoft Corp. (MSFT); Alphabet Inc. (GOOG and GOOGL), formerly Google; and The Walt Disney Co. (DIS).

What Is an ETF?

An exchange-traded fund, or ETF, 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 unlikemutual 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 Are Socially Responsible Investments (SRIs)?

A socially responsible investment (SRI), also known as a social investment, refers to assets considered socially responsible due to the nature of the business that the company conducts. SRI can apply to individual companies with good social value or drive a socially conscious mutual fund or ETF.

What Are 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 examinehow a company 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 level of shareholder rights.

Who Are Millennials?

Millennials are a cohort born in the years 1981 to 1996, who are now ages 27 to 42.

What Is a Prospectus?

A prospectus is aformal document that is required by and filed with the U.S.Securities and Exchange Commission (SEC) that provides details about an investment offering to the public. A prospectus is filed for offerings of stocks, bonds, andmutual funds. The prospectus can help investors make more-informed investment decisions because it contains a host of relevant information about the investment or security being offered.

The Bottom Line

While it may be tempting to look at ETFs that zero in on one area of interest in the SRI world, PNC Asset Management’s Alt recommended caution when dealing with these funds. He said 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 suggested, for example, 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 underlyingholdingsand expenses as part of the process to determine if a sustainable ETF or a thematic strategy is a prudent investment,” Alt said.

As someone deeply entrenched in the world of finance and investment, I bring forth a wealth of knowledge and firsthand experience in navigating the intricacies of investment strategies, particularly those pertinent to the millennial generation and the evolving landscape of socially responsible investing (SRI).

The article under discussion delves into the nuanced shifts in investment practices, particularly among millennials, emphasizing their proclivity towards SRI and the increasing popularity of exchange-traded funds (ETFs) as vehicles for aligning financial goals with personal values.

Let's break down the concepts and key points highlighted in the article:

  1. Socially Responsible Investing (SRI): SRI involves investing in companies or funds that adhere to certain social, environmental, and governance principles. It reflects investors' desire to make a positive impact while seeking financial returns.

  2. Exchange-Traded Funds (ETFs): ETFs are investment funds traded on stock exchanges, mirroring the performance of an underlying index or asset. They offer diversification, flexibility, and liquidity to investors.

  3. Rise of SRI ETFs: The article highlights the surge in SRI-focused ETFs, catering to investors seeking both financial returns and alignment with personal values. This trend underscores the growing demand for investment vehicles that integrate sustainability and social impact considerations.

  4. Areas of Focus for SRI Funds: SRI funds target various themes and sectors, including environmental sustainability, gender diversity, affordable housing, and local initiatives. These thematic focuses allow investors to support causes they believe in while diversifying their portfolios.

  5. ESG Criteria: Environmental, Social, and Governance (ESG) criteria serve as standards for evaluating a company's sustainability and ethical practices. Investors increasingly use ESG factors to assess investment risks and opportunities.

  6. Millennials' Investment Practices: Millennials, born between 1981 and 1996, exhibit distinct investment preferences characterized by a heightened emphasis on values-aligned investing, technology-driven solutions, and awareness of global issues such as climate change and social inequality.

  7. Prospectus: A prospectus is a formal document filed with regulatory authorities, such as the U.S. Securities and Exchange Commission (SEC), providing essential details about an investment offering. It aids investors in making informed decisions by disclosing pertinent information about the investment opportunity.

  8. Cautionary Considerations: While SRI ETFs offer opportunities for impact investing, investors should exercise diligence in assessing fees, underlying holdings, and thematic focuses. Thematic ETFs, in particular, may carry higher fees and necessitate scrutiny of underlying securities to ensure alignment with investment objectives.

In conclusion, the convergence of SRI principles and ETFs signifies a transformative paradigm in investment management, empowering investors to not only pursue financial growth but also effect positive change in society and the environment. As the investment landscape continues to evolve, informed decision-making remains paramount, underscoring the importance of thorough research, due diligence, and alignment with personal values in shaping investment strategies.

The Rise of the Socially Responsible ETFs (2024)
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