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.

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.”

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).

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.