So-called Socially Responsible Investing is a big trend on Wall Street these days. ETF investors can get in on the gambit with the iShares KLD Select Social Fund (NYSEARCA:KLD). The fund which the index tracks selects stocks from the Russell 1000 (an index of large and mid-cap domestic stocks) screened based on non-economic criteria that KLD considers socially desirable, such as workplace diversity, product quality & safety record, environmental friendliness, etc. The index also excludes all tobacco-related stocks, but does include some holdings that might surprise you, such as Exxon Mobile (NYSE:XOM).
That’s all fine. However, the problem is that socially responsible investing probably doesn’t work. I have been unable to find any convincing evidence which shows that SRI benefits anyone, either by delivering superior investment returns, or by encouraging companies to “do the right thing” in order to be included.
But the real kicker is that KLD is likely to underperform the Russell 1000 going forward as well, because by selecting stocks based on non-economic criteria, the index provider has created a portfolio with inferior fundamentals.
Specifically, compared with the Russell 1000 from which they are drawn, the stocks in KLD have delivered slower earnings growth over the past five years, are expected to do so again this year and going forward over the long term (Figure 1). Despite this, KLD trades at a price-to-earnings premium versus the Russell 1000, at 15.6x and 14.8x 2008E EPS, respectively.
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On top of all that, KLD charges you substantially extra for the privilege. The annual expense ratio for KLD is 50 basis points, compared with just 15 for the comparable iShares Russell 1000 fund (NYSEARCA:IWB). How responsible is that?
The net result of all this is that while you may be feeling better about yourself for investing “responsibly,” you’ll probably also feel poorer, at least in the long run. So if you want to do good, get rich investing wisely, and then give your money away to a worthy cause.