Equity Index Funds for the Socially Responsible

Last week I shared my interview with Timothy Nash, president of Strategic Sustainable Investments, the blogger behind The Sustainable Economist, and an expert in socially responsible investing (SRI). This week I’d like to profile a number of investment products that may be appropriate for Couch Potato investors who are interested in SRI.

I’m not endorsing any of these investments: I don’t use any of them myself, and although I’ve made an effort to understand what they have to offer, I haven’t performed any due diligence on them. You’re responsible for thoroughly checking out any investment before adding it to your portfolio.

Canadian equities

The iShares Jantzi Social Index Fund (XEN), launched in 2007, tracks the best-known SRI benchmark in Canada. The Jantzi Social Index excludes companies involved in military contracting, nuclear power and tobacco, as well those involved in “significant controversies” such as environmental spills. The index includes 60 companies and is designed to roughly mirror the sector weights of the S&P/TSX 60. For what its worth, XEN has outperformed the iShares S&P/TSX 60 (XIU) over the five years ending in April despite is much higher fee (0.55%).

The Meritas Jantzi Social Index Fund tracks the same index, but the manager has also “added further screens in the areas of alcohol, gambling and pornography.” This mutual fund is a lot more expensive than its ETF counterpart: the A Series has an MER of 2.23% plus loads, and the F Series charges 1.30%. But it has a much more activist mandate that some SRI investors may be willing to pay for. Meritas has a long record of shareholder engagement, which the iShares ETF does not share. The fund also allocates a small share of its assets to community development investments that “foster sustainable social and economic well being.”

US equities

The US family of iShares ETFs offers two index funds for socially responsible investors. The iShares MSCI Socially Responsible ETF (DSI) holds 400 large, mid and small-cap stocks screened for “positive ESG [environmental, social and corporate governance] performance relative to their industry peers.” The index gives the boot to companies involved in “alcohol, tobacco, firearms, nuclear power, military weapons and gambling.”

The iShares MSCI Select Socially Responsible ETF (KLD) focuses on fewer and larger companies: it includes about 130 stocks with a median market cap about twice as large as that of DSI. It also screens for companies with high ESG ratings, though the only business activity specifically excluded is tobacco.

The sector breakdown in these two indexes is roughly the same as the broad market so they “exhibit risk and return characteristics similar to the MSCI USA Index.” The MER on both funds is 0.50%.

Importantly, these iShares ETFs have a clear proxy voting policy “consistent with the principle that ‘socially responsible’ shareholders are concerned not only with economic returns and sound corporate governance, but also with the ethical behavior of corporations and the social and environmental impact of their actions.”

International equities

When it comes to SRI index funds tracking companies outside North America, the pickings are slim. The only ETF that fits the bill is the Pax MSCI EAFE ESG Index ETF (EAPS). The index is designed to mirror the popular MSCI EAFE Index, so the largest country allocations are Japan and the United Kingdom, and the largest sector weights are financials, consumer retailers, and health care. From a universe of almost 1,000 stocks, the index screens for the top 150 or so with the highest ESG ratings. The ETF’s management fee is 0.55%.

Pax World has been in this space for a very long time, and they also perform shareholder engagement, which is why I really like them,” Tim Nash told me in our interview. But this ETF very small, with just $30 million in assets. Indeed, one potential problem with SRI funds is they’re often slow to attract investors and are vulnerable to closure: Pax World used to offer a North American equity ETF with a socially responsible screen, but that fund was shuttered in March. (If a fund closes you don’t lose your money: you’re just forced to liquidate. But in a nonregistered account, a forced sale can stick you with capital gains taxes.)

Later in the week I’ll look at fixed income options for socially responsible Couch Potatoes.

6 Responses to Equity Index Funds for the Socially Responsible

  1. Tom Hart May 22, 2013 at 9:52 am #

    There are some interesting issues here.

    One, the methodology used by these indexes, which I was not aware of, highlights how subjective these values are. I have no problem with military contracting, nuclear power, tobacco, gambling, or pornography, but I do have an issue with carbon emissions.

    Two, if the fund always votes with management, the value is suspect. You would need a lot of people to buy these funds to effectively depress the stock price of these companies. Furthermore, even if you manage to depress the price (doubtful), all you can hope for is that the other shareholders pressure management to adopt policies that make the company get a better SRI score — and that doesn’t help *at* *all* if a sector has been blacklisted from the fund entirely. This makes me think of the academic fossil fuel divestment campaign promoted by 350.org: the argument is that we should deny fossil fuel companies capital, which is senseless if you already own shares which trade on a secondary market; you’re only denying a fossil fuel company capital if you refuse to participate in an IPO or buy its corporate bonds. Furthermore, again, divesting from an industry entirely robs you of an opportunity to vote on a company’s policies.

    I do see value in these indexes if you want to buy individual stocks. I bought Suncor since it had an attractive valuation and scored well on the Jantzi index, especially due to the wind farms they operate. I appreciate that the number of votes I have is insignificant to Suncor, but I do plan to write them a letter to the effect of, “I am a long-term investor who wants to hold my shares in this company for the next 30 years. I would accept lower returns in the short term to see more investment in carbon capture (so that bitumen is more marketable internationally) and in renewable energy (so that I own shares in an *energy* company that can keep generating profits regardless of oil reserves).”

  2. Canadian Couch Potato May 22, 2013 at 10:17 am #

    @Tom: It’s certainly true there’s a lot subjectivity in the selection process, and it would be very hard to find an index that perfectly mirrors your own values. I suppose you need to compromise at some point, or you’re faced with building a portfolio of hand-picked individual stocks, which is hugely risky.

    I’m not sure I understand your comment: “You would need a lot of people to buy these funds to effectively depress the stock price of these companies.” Why would the fund’s objective be depressing the stock price of the companies it holds?

  3. Tom Hart May 22, 2013 at 10:56 am #

    I should have been more clear: the goal of an SRI fund is to raise the value of the companies it holds/overweights and depress the value of the companies it excludes/underweights. For example, the Jantzi social index overweights Suncor at the expense of other oil companies, thus depressing (or attempting to depress) the value of the less responsible oil companies.

    My point is that a huge number of investors would need a significant chunk of their assets in funds like XEN for that to make a real impact, and that isn’t the case: XIU alone has around 50x the assets under management of XEN, and there are a lot more large funds and ETFs than XIU. I don’t know which Canadian oil company is the worst in terms of corporate responsibility, but I don’t think that company’s management is saying, “We need to clean up our act, since a bunch of SRI investors are depressing our stock price by refusing to buy us, and this is going to get our shareholders upset.”

  4. Canadian Couch Potato May 22, 2013 at 11:21 am #

    @Tom: I’m not sure I agree the goal of an SRI fund is to drive down the price of companies excluded from the index. As you say, that would never work anyway.

    I think we need to get past the idea that buying a stock is somehow rewarding a company, and not buying it is a punishment. All shares have to be owned by someone. It has more to do with taking an active role as a shareholder in the companies you do own, and it has to do with what allows you to sleep at night.

  5. brad May 23, 2013 at 6:40 am #

    Timothy Nash posted a useful link in the comments of your previous article (part 2 of the interview) to a database of shareholder resolutions and their outcomes. So now I am convinced that shareholder activism can indeed have some impact, but this raises another question. If SRI funds have “more to do with taking an active role as a shareholder in the companies you do own,” then it seems like investors who want to encourage more socially and environmentally responsible business practices should buy shares in “bad” companies so they have an opportunity to improve them via shareholder activism. There’s a limit to how much you can do, of course; no shareholder resolution could ever convince a tobacco company to stop selling tobacco products. But if you disagree with the business practices of, say, Wal-Mart, Exxon, or Monsanto, it seems like you should own shares in those companies so you can play a role in changing their behaviour.

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