Twenty20 Investments - iBasket

11. October 2015 15:50
by Allan

Are you missing out on the benefits of Socially Responsible ETFs?

11. October 2015 15:50 by Allan | 0 Comments

Like most things in life, overnight success often takes ten or more years to come to fruition, and so it is with Socially Responsible Investing, SRI. Figures published in 2014 by the Forum for Sustainable and Responsible Investment, a US association comprising institutions and organizations, suggest an estimated $6.57 trillion of assets in the US tracking SRI strategies.



Screening on Social, Environmental and Corporate Governance

Hardly a drop in the ocean as this accounts for more than one sixth of all assets held by professional managers in the US. No wonder there has been a push by MSCI into this space with their ESG, Environmental Social Governance, family of indices. This in turn has seen UBS throw their hat in the ring as their ETF division partnered with MSCI to benchmark their products.

The methodology by which each index provider has designed their SRI screening of companies on one level can be nuanced, but on another is very straight forward to understand: if as a company you are not acting in a socially and environmentally-friendly manner, you are not allowed in as your name is not on the list! Interestingly, none of the MSCI indices includes Volkswagen, but to get a flavour, just look at the top 5 holdings of the ETF providing exposure to the UK large cap sector and this includes Astra Zeneca, GlaxoSmithKline, Reckitt Benckiser, Vodafone and Prudential.

The MSCI SRI equity indices are re-balanced quarterly and comprise those companies with a ‘Best-In-Class’ ESG rating and who are not involved in the following industries; Military Weapons, Nuclear Power, Adult Entertainment, Tobacco, Alcohol, Civilian Firearms, GMOs and Gambling. The weightings of each constituent match the sector and regional weighting of the parent MSCI ACWI index, thus avoiding any unnecessary systematic risk introduced by the SRI filtering process. The ESG rating framework itself is very rigorous, scoring a company on a scale from AAA to CCC, with 37 key issues monitored on an annual basis contributing to the rating. Other screening processes, like for the iShares Sustainability ETFs, work on a similar basis.

The history of socially responsible investing in the UK can be traced back to the FTSE4Good set of indices which were launched in 2001, but it wasn’t until early 2011 that the first SRI ETF was listed on the London Stock Exchange, the iShares Dow Jones Europe Sustainability Screened UCITS ETF. With a family of six ETFs tracking the MSCI Socially Responsible indices, UBS is the clear market leader. More recently they have listed a corporate bond ETF with SRI screening, the UBS Barclays MSCI US Liquid Corporates Sustainable UCITS ETF, (Bloomberg Ticker UC98), which is very welcome as this offers the opportunity to implement a diversified SRI portfolio solution using ETFs.

ETFs with SRI screening

Source: Twenty20 Investments, as of 11 October 2015

There are two reasons why an investor might want to get exposure to SRI. The first is the obvious one, it hopefully makes us feel good to invest in ‘good’ companies. The other belief is that companies are included in the index because it is deemed that displaying attributes of good corporate governance, and social and environmental responsibility are good drivers of long term investment returns, and yes I do personally believe that as well. Looking at the ESG-screened MSCI UK equities index, as of 30 September 2015, the one year net index performance reported by MSCI is 2.2% compared to that of the standard MSCI UK index which was down 5.9% during the same period. A nice surprise indeed, but please do not expect this kind of outperformance all the time.

It strikes me that the whole SRI story could easily become re-enforcing as the finance services industry continues to shore up its reputation. With an ever growing number of institutional investors increasing their allocation to SRI benchmarked strategies, on a ‘sticky money’ basis alone, it is time to pay attention.

Thank you for visiting the ETF Managed Portfolios Blog Top