Investing With A Conscience Or The Problem With Socially Responsible ETFs

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Includes: DSI, ETHO, LOWC
by: Maralto Investments
Summary

Three ETF's within the 'social' and 'ethical' ETF space are analyzed for applicability of investment.

Holdings are reviewed to ensure compatibility with ETF objective.

Recommendations are made for investment based on stated criteria.

As most other young investors that began their journey in the capital markets, social and ethical responsibility did not factor into my initial assessment of companies. My goal was to find profitable companies that paid a dividend that was well covered with an expectation of growth. However, over the past year I have begun to wonder if profit should only be one piece of the analysis rather then the primary objective.

Investing with a social and ethical conscience is a relatively new type of investing style. Broadly defined a company's profit potential is analyzed alongside the social impact and ethical implications of their products and business operations. While earning a return on capital is important and arguably the primary objective of capital investment, other values need to be taken into consideration before an investment is made.

Investing capital in a company is affirming value in and of that company and I do not want to affirm value in businesses or governments that purposefully harm people or those entities whom act negligently toward their use of the environment, through their own ignorance or by direct action.

To summarize my overall views in a sentence, I do not consider globalism as a valuable tool when it does not export positive social values and legal protections for workers and the environment along with capital.

I value my neighbors and fellow tax payers, and want them to be successful and able to support themselves and their families. I value the legal protections of my countries workers more then I value low cost goods. If I am to make a choice on valuing my local citizens over foreign citizens, I choose to empower those locally with my capital investment and expenditures.

With this mindset, and living in Canada, I am finding my investment selection fairly limited. At the onset of this research I have turned to some ETF's that promote being "socially responsible" or "ethical" and have found some interesting results. Below I analyze a few of these options:

1) iShares MSCI KLD 400 Social ETF - DSI

An overview of this ETF:

DSI is a viable choice for those wanting a socially conscious ETF while maintaining reasonably market-like exposure. Limiting its holdings to firms deemed to be socially responsible, from an environmental, social, and governance ("ESG") standpoint. In practice, this means explicitly excluding firms who are significantly involved with weapons manufacturing, "vice" products, nuclear energy and genetic modification.

This seemed to be a good option based solely on the synopsis but investigating the holdings showed a different result. Within the top 15 are both Coca Cola and McDonalds. While these companies offer varied products, most are unhealthy and are exacerbating the obesity crisis that we see around the world today. If the research is to be believed that sugar has the same effect on the brain as cocaine, then Coca Cola surely should not be a worthy investment from an ethical or social standpoint.

2) Etho Climate Leadership U.S. ETF - ETHO

An overview of this ETF:

ETHO tracks the Etho Climate Leadership Index - US, which is composed of U.S. equities with the most climate efficiency within their own sectors. Each company is measured according to their climate impact, which is calculated based on total greenhouse gas emissions from operations, fuel use, supply chain, and business activities, divided by market capitalization. The top scoring half in each industry is selected, while simultaneously excluding all companies in energy, tobacco, aerospace and defense, gambling, gold, and silver sub-industries.

As part of the construction of this ETF, each holding is equal weighted. This option is not a bad choice for someone looking for an algorithmic approach based on GHG emissions and market size. With such a large selection (290) of companies however, the likelihood of all business activities being confined to countries within the aforementioned criteria is near zero. However, this is still a good option but does come with an expense ratio of 0.49% and only marginal annual distributions.

3) SPDR MSCI ACWI Low Carbon Target ETF - LOWC

An overview of this ETF:

LOWC wants to do good for the planet while maintaining market-like returns. The new fund selects stocks issued by firms with a tilt toward a smaller carbon footprint, as measured by lower greenhouse gas and carbon emissions, relative to sales and market cap, respectively.

This is an ETF that is built mathematically. It is this authors opinion that "social" or "ethical" investing should be a more human directed qualitative approach such as ETHO, and not so heavily reliant on mathematics or attempting to track an index as seen here.

Unfortunately within this ETF Nestle is within the top 10 by holdings. It is well known that Nestle is unnecessarily draining aquifers around the world for one time water drinking use in plastic bottles. This is a prime example of where profit is being put ahead of all else, and as such I cannot agree with the practice or make an investment here.

Conclusion

ETF's encourage passivity, and it is easy for investors to lose track of the companies with which they are investing. As I have shown above it is important to investigate the holdings of these ETF's to ensure they comply with their stated objectives.

Good businesses are designed to make profit for shareholders. However I have come to expand my understanding of my investment style such that maximizing profit cannot be the only motivator in my decisions. Investing for profit while ignoring the effects of said investment is shortsighted.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ETHO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.