Anything mutual funds can do, exchange-traded funds can do at least as well.
Oh, wait. There’s one exception – ETFs just won’t cut it for building a socially responsible investment portfolio.
It’s not because the ETF options available to socially responsible investors are lacking. Actually, they’re attractive from both a cost and performance point of view. The problem is the lack of a well-rounded menu of funds that can be used to build a properly diversified portfolio. Mutual funds offer this to socially responsible investors, but ETFs don’t – at least not yet.
According to the Social Investment Organization, an association that promotes socially responsible investing, the amount of money invested in SRI mutual funds at the end of 2010 represented 5 per cent of Canada’s retail mutual fund market. There’s only one Canadian SRI exchange-traded fund, and it accounts for about 0.5 per cent of total ETF assets.
ETFs, in their classic form, are index-tracking funds that trade like a stock. They’re much cheaper to own than mutual funds, and they provide a simple way for investors to buy into hundreds of Canadian, U.S. and international stock and bond indexes. Among them are the Jantzi Social Index, a benchmark for SRI investing in the Canadian market, and the MSCI KLD 400 Social Index, which performs the same function in the United States.
The Jantzi index has been used for the one socially responsible ETF listed on the Toronto Stock Exchange, the iShares Jantzi Social Index Fund (stock symbol: XEN). The management expense ratio (MER) for this ETF – that’s the most commonly used measure of how much it costs to own a fund of any type – is 0.53 per cent. That’s a true bargain in comparison to the 2.34 per cent MER of the Ethical Growth Fund, one of the largest SRI mutual funds in the country. Fees are paid out of ETF and mutual fund returns, so lower is always better (note: returns are always shown on an after-fee basis).
The cost of owning the iShares Jantzi ETF also looks cheap compared with the Meritas Jantzi Social Index Fund, a mutual fund that tracks the same underlying index. The Meritas fund has an MER of 1.94 per cent – look no further if you’re wondering why it made 8.4 per cent in average annual returns for the three years to Nov. 30, 2011, while the Jantzi ETF made 10.1 per cent.
The Jantzi Social Index draws its companies from among the largest in Canada that have passed through screens for environmental, social and governance factors. Excluded are companies involved in nuclear power, military weapons and tobacco. Returns for the ETF based on this index have been quite solid compared to non-SRI alternatives. Over the three years to early December, the Jantzi ETF outperformed the giant $10.9-billion iShares S&P/TSX 60 Index Fund (XIU) 39.4 per cent to 37.8 per cent on a cumulative basis. And yet, the Jantzi ETF has attracted just $19.3 million in assets, a tiny amount. “The assets under management for this ETF tell you the story,” said Mark Yamada, a long-time user of ETFs as president of PUR Investing. “I think the pickup by investors has probably been under the expectations of the provider.”
This helps explain why ETF providers haven’t followed the lead of the mutual fund industry and made a broadly based move into SRI products. There are nine different SRI Canadian equity mutual funds for investors to choose from, plus various options for adding bonds, U.S. and global stocks as well as small-size Canadian companies. There are also many SRI funds to choose from in the balanced category, which has been a favourite of investors in recent years.
Mind you, it is possible for Canadians to invest in socially responsible ETFs built on U.S. companies. One option is the iShares MSCI KLD 400 Social Index Fund (DSI-NYSE), which focuses on best-in-class companies based on environmental, social and governance factors. The other is the iShares MSCI USA ESG Select Social Index Fund (KLD-NYSE), which sticks to large-size companies and is less strict in terms of what sectors it will avoid (just tobacco, compared with tobacco, gambling, alcohol, firearms, nuclear power and military weapons for DSI).
Investors with a high tolerance for risk – losing money, in other words – might consider a pair of what might be described as honorary SRI ETFs. One is the PowerShares Cleantech Portfolio (PZD), which is based on an index designed to track leading clean technology companies. The other is the PowerShares WilderHill Clean Energy Portfolio (PBW), which invests in companies in the business of developing green and renewable energy sources.
The quickest way to gauge the popularity of an exchange-traded fund is to look at its daily trading volumes. From this point of view, only the PowerShares WilderHill Clean Energy Portfolio can be said to have gained a significant following among investors. The others, including the TSX-listed Jantzi ETF, generate what would be considered low volumes that on a typical day could be as low as a few thousand or even a few hundred shares.
Ironically, it’s the PowerShares WilderHill Clean Energy Portfolio that has by far the worst performance of any socially responsible ETF. Over the five years to early December, it lost a staggering 70 per cent of its value on a cumulative basis. As for the largely overlooked KLD 400 and ESG Select Social ETFs, they have both consistently outperformed the S&P 500 index, which is the benchmark for the U.S. stock market.
PUR Investing’s Yamada credits the mutual fund industry with doing an effective job of teaching consumers that the fund world offers many options for socially responsible investors. ETF providers have taken the approach of letting SRI investors come to them, which has not proven as effective.
Yamada thinks this could be a generational issue. He said baby boomers have the most money to invest, but they have shown a modest level of interest in socially responsible investing.