Why Socially Responsible ETFs Haven't Taken Off (KLD, PBW)

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Includes: KLD, PBW
by: Market Participant

A recent article in Institutional Investor discussed the seeming lack of interest in socially responsible ETFs -- specifically, the iShares KLD Select Social Index (NYSEARCA:KLD). The KLD index is based on the Russell 1000 index, with tobacco companies excluded. The index methodology then optimization scheme to favor socially responsible companies while not having more than 2% tracking error to the Russell 1000 index:

Looking at the fund's performance over the past year, KLD's quantitative strategy has been quite successful at matching the benchmark index. The very low trading volume relative to the number of KLD shares outstanding can easily be explained by most owners of KLD being buy-and-hold types rather than active traders. SDY also has ridiculously low volume relative to size for the same reason.

I think the main reason for lack of interest in socially responsible funds is that most investors agree with economist Milton Freedman that the social responsibility of business is to increase its profits. Indeed according to Prof. Jeremy Siegel, Ben Bernanke's Favorite Stock is Altria (NYSE:MO) (f.k.a. Phillip Morris).

Socially responsible investing suffers from socially desirability bias -- the tendency for people to claim things about themselves which are socially desirable. A classic example is flossing your teeth -- most people, when asked, will claim that they do floss their teeth, even though in reality regular flossing is quite rare.

The article notes that:

according to Calvert, more than half of all non-SRI investors are “interested