Socially Responsible Portfolio

[Gondolin]

Ok, maybe I can bring some clarity to that as my company manages some funds that have a “green” label.

Usually, those strategies are referred to as “ESG” for Environmental, Social and Governance oriented. As was mentioned before, everybody has differing opinions on what that should be, so read carefully what you are buying.

Just excluding some stocks based on their industry or business model is probably the easiest “quick and dirty” solution. Other models try to influence businesses or pressure them through voting rights. Or, you buy only firms that “do good” if you like to really feel good about your investments. There is no stringent research if those ESG strategies add or detract from standard stock market returns, you will find studies that confirm one of those outcomes.

If you buy the above mentioned ETFs you can be pretty sure that it is a simple screen that excludes certain industries (alcohol, tobacco, gambling, etc.). Personally, I would not invest the majority of my money in such strategies. The ETFs are too simple and the active strategies are too expensive. However, most asset managers now have to adhere to the PRI (Principles for Responsible Investing) anyway, a lot of institutional clients will not invest with you if you a not a signatory of the UN PRI charter. Also, most clients automatically exclude certain investments, for instance producers of Landmines.

And, if you don’t give a shit there are even ETFs for “sin stocks”, that invest only in companies that make high margins in alcohol, tobacco, sex or firearms:
WSKY - as the name says, “spirited funds” ETF
BJK - gaming ETF
ACT - tobacco, marijuana and alcohol

So, you can choose if you want to embrace the dark side or not…

All the best
Gondolin

[derpinator]

I recently got so XAR for the lolz.

Weapons are ok but tabacco is where I draw the line, no idea what that tells you about me.

[rolandinho]

Aerospace and defense sounds legit, as long as it’s only defense and no attack weapons, right?

[derpinator]

Well they do make some space stuff too XD

[bamboo]

Interesting discussion that shows that sustainable or socially acceptable is a definition with variable geometry.
One question comes always in my mind: why investing in socially responsible ETF, you expect a better long term return or you want to sleep without bad feelings?
We could discuss if on the long term the consequence of civil nuclear energy is better or worst than climate change due to CO2 from fossil fuel.
But the final question for me is who is really responsible of the consequence, the investor or the consumer? In this debate I have the feeling that once more the investor is described as a greedy capitalist ready to sell the planet for some more profit. What about the responsibility of the consumer of fossil fuel, long distance travel or precious metal and rare earth? In a market there is always two people and I doubt the the investor is more to blame than the consumer of some questionable products.
As an investor (or indirectly, the investment company providing ETF) you can ask some question about the business continuity policy of the companies you have invested in. This is probably the most constructive approach.

[arheom]

I am also trying to invest a bit more sustainable, but I am trying to put on a balance the TER vs Sustainable score as well. For example, my portfolio (on paper) is looking like that now:

35% US ETF - 0.12% US - ESGV
35% Rest of the world - 0.15% US - VSGX
10% Swiss ETF - 0.10% CH - CHSPI
10% Bonds - 0.05% US - AGG
10% Focused ETFs - 0.50 % US - ICLN, CRBN, SDG, IRBO

The ESGV and VSGX are the Vanguard ETFs, screening out some industries. But it is not integrated with the ESG process, because I found those ETFs have the TER too high and I still could find issues with the companies in there…so until they fix the ESG integration I am not ready to pay the higher costs (like paying the high price to invest sustainable in Nestle…).

The CHSPI is not even screened out, but I find the UBS products way too expensive for only screening out some companies and still contains lots of companies I would not want to invest in. So, until I find an alternative, I will use the iShares product.

The AGG is low cost aggregated bonds, mostly in US, where there is a positive interest (still)…even I am still thinking if makes sense to invest anything in bonds now, when FED is turning back the QE, so maybe later on will reduce the interest rate…maybe I will just have the cash sitting around there.

The focused ETFs are more high priced, but only 10% from the investment, where I rotate some ideas I consider might be successful in the future, but with higher risks.

But, at the end, I would like to invest sustainable, but not just to pay a very high price to some ETFs labeled as sustainable, but containing lots of companies which I do not consider sustainable. Till the ESG integration process will be better, I will invest in lower cost ETFs which will only screen out some industries (even…only for screening out some industries…still charges quite a bit compared to the original ETFs…but at least low enough for me…).

[Bibi4]

More like a politically correct Portfolio than a socially responsible one…

OGMs and Nuclear are not popular all right, but that doesn’t make them “socially irresponsible”.

[nabalzbhf]

It’s a pretty interesting topic, thanks. Are you aware of the ideas from https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-One-Mans-Ceiling-is-Another-Mans-Floor?

My understanding is that if it’s working you should expect lower return (and that the people not doing “responsible” investing will get the money instead).

As you and Bibi4 noted, it’s usually hard to agree 100% (or even 50%) with the SRI definitions that are used.

Regarding AGG, I assume you don’t care about the currency risk? (currency volatility will dominate the returns).

[arheom]

@Bibi4

OGMs and Nuclear are not popular all right, but that doesn’t make them “socially irresponsible”.

Well…this is one of the main issues…sustainability can be interpreted in many ways, like environmental impact (CO2, intensive farming, pollution, chemicals…), social inequality, wealth distribution…and on one side, one company can have a big impact on environment, but have good score on social inequality, so overall, will be fine and get into the index.

So, I think it is important to see the companies inside the “sustainable index” and decide on your own if you would like to invest in them, depending what sustainability is for you…

[arheom]

@nabalzbhf

My understanding is that if it’s working you should expect lower return (and that the people not doing “responsible” investing will get the money instead).

Yes, I do expect lower returns now (plus the slightly higher TER) and maybe in the mid-term future more returns, but not from these ETFs…but more for a better integrated ESG ETFs, mainly because I expect more regulations and higher taxes in a mid-far future.

@nabalzbhf

Regarding AGG, I assume you don’t care about the currency risk? (currency volatility will dominate the returns).

Well…here I have some more issues and indeed currency risk is as well quite important. But, I think also Europe is not doing great and Switzerland does lot of business with EU, so it can go both ways. But here I tend to keep more cash and use it when stocks get cheaper…still thinking to it.

Do you see any good reason nowadays to hold bonds?

[nabalzbhf]

@arheom

Do you see any good reason nowadays to hold bonds?

My personal opinion is that if you care about EUR or CHF, holding cash it likely better since risk-free bonds have negative yields.

[trotro]

My 5 Rappen:

In my opinion it is very well possible that, if you want to do good in the world or prevent harm, a socially responsible portfolio isn`t especially conducive to either goal.

• It’s a lot of work and needs quite a bit of skill to screen stocks/indices for your understanding of ‘socially responsible’.
• You are likely to get lower returns with a socially responsible portfolio than from a standard one.
• Socially responsible investing might not as big an effect as you`d hope for.

You might get lucky with the first one, if your values happen to align with an ETF like the one from UBS you mention.
But for me, and I suppose for many others, these portfolios might not align.

• Alcohol (Maybe a good thing.)
• Gambling (Feel pretty neutral about it.)
• Tobacco (Probably a good thing, but if excluding all nicotine products maybe not something I care about greatly.)
• Military weaponry (Probably a good thing.)
• Civilian firearms (A good thing.)
• Adult entertainment (Feel pretty neutral about it.)
• Genetically modified organisms (Most likely a bad thing, would like to support certain GMO-companies (over others).)
• Nuclear energy (Same as with GMO.)

For me, not investing in companies that are strongly involved with factory farming would probably trump all the listed points.

Let`s say you care a lot about climate change.
I think your choice is between

• spending time searching for a green fund, which seems sensible to you and then getting less returns (in expectation)
• investing in a standard fund, donating the additional money you get and the value you place on the time you didn`t spend researching this topic to an effective climate change charity (e.g. "Coalition for Rainforest Nations)

Obviously, which of these options is better at producing your end goal depends on a lot of things (how effective are those climate change charities vs. socially responsble investing, roi for green vs. standard etf, how much time do you spend with research and how much do you like spending your time like that etc.).

[wapiti]

@arheom

The ESGV and VSGX are the Vanguard ETFs, screening out some industries. But it is not integrated with the ESG process,

What do you mean by “it is not integrated with the ESG proces”, these two fund are completly integrated in the ESG process. But that’s right you can find funds which have an higher ESG score like

• iShares MSCI U.S.A. ESG Select ETF
• Xtrackers MSCI EAFE ESG Leaders Equity ETF
• iShares ESG MSCI EAFE ETF

You can find ESG scores under https://www.etf.com/etfanalytics/ and The Web's Best ETF Screener | ETF Database

VSGX already covers Switzerland

I woudn’t invest in bonds and 10% of focused ETF are too low to make a meaningful impact on the returns.

[Bibi4]

@trotro

In my opinion it is very well possible that, if you want to do good in the world or prevent harm, a socially responsible portfolio isn`t especially conducive to either goal.

I can only concur. If you are buying only “socially responsible” stocks from the hand of other investors and disregard the rest of the market what kind of positive effect is expected as a whole? As I see it would artificially bolster the market capitalisation of those “good” companies and lower the value of the others. The only effect I see is that it will create opportunities for rational investors and make the socially responsible investors poorer by buying overpriced stocks. How is that achieving anything positive in the real world?

[male]

social group pressure: if such labels become a trend in the finance world you could imagine an effect where non-labelled companies have higher financing costs as no one wants to finance them (higher interest on credit). also it can influence business itself if customers start to require such labels (less revenue due to bad marketing). if it stays limited to who owns the stock then agreed the effect is limited.

[Gotama]

I’ve recently stumble upon two different types of socially responsible “funds”, that go beyond thé simple “Green label” that dont changes much.

The Swiss alternative Bank has “stocks”, non traded on exchange, that are used to back up micro loans in Swiss. They say they have around 2% averaged return pa. https://www.bas.ch/?id=556

The second option, which seems more Interesting to me, is the ethos fund. It is basically a finma approved fund that tracks msci world or other index, and that sits on the executive boards of the companies it has sufficient shares in. It then try to up or down votes the decision of the boards that are in conflit with it’s ethic chart. https://www.ethosfund.ch/fr/a-propos-d-ethos/portrait-d-ethos

Have you Heard about them ? I’m still reading about it to see whether it’s honest or not.

[wapiti]

Ethos funds are quite expensive. More and more ETFs which are socially responsible are available at low cost. However, there are multiple levels of socially responsible funds and you can get lost easily. I will try to sum up with the MSCI indices:

• MSCI World (1654 stocks): standard index

• MSCI WORLD ESG UNIVERSAL INDEX (1622 stocks selected out of 1654): The index is designed to reflect the performance of an investment strategy that, by tilting away from free-float market cap weights, seeks to gain exposure to those companies demonstrating both a robust ESG profile as well as apositive trend in improving that profile, using minimal exclusions from the MSCI World Index.

• MSCI WORLD ESG SCREENED (1552 stocks selected out of 1654): The index excludes companies from the parent index that are associated with controversial, civilian and nuclear weapons and tobacco, that derive revenues from thermal coal and oil sands extraction and that are not compliant with the
  United Nations Global Compact principles.

• MSCI WORLD ESG LEADERS (799 stocks selected out of 1654): The MSCI World ESG Leaders Index is a capitalization weighted index that provides exposure to companies with high Environmental, Social and Governance (ESG) performance relative to their sector peers

• MSCI WORLD SRI INDEX (390 stocks selected out of 1654): The MSCI World SRI Index includes large and mid-cap stocks across 23 Developed Markets (DM) countries. The index is a capitalization weighted index that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts
  Similar index: MSCI WORLD SRI 5% ISSUER CAPPED INDEX

I don’t know in which universe you are looking, but I would recommend the following ETFs with high ESG score:

• UBS ETF (LU) MSCI World Socially Responsible UCITS ETF (USD) A-dis (unfortunately, this fund is LU based)
• iShares Sustainable MSCI USA SRI UCITS ETF
• iShares MSCI Europe SRI UCITS ETF
• iShares MSCI U.S.A. ESG Select ETF
• iShares ESG MSCI EAFE ETF

For US based ETFs, you can use https://www.etf.com/etfanalytics/etf-finder, the ESG tab displays the ESG score of the fund

The ESG score is strongly dependent on the industry of each country.
Some countries will have automatically better score due to their industry (like Portugal, Netherland). Emerging markets have a lower score, so it would be better to avoid them.

The world Ethos fund is “Ethos - Equities Sustainable World ex CH - E” with a cost of 0.71% including 100 stocks. Is this fund more socially reponsible than UBS ETF (LU) MSCI World Socially Responsible UCITS ETF?. It’s hard to say without an independant comparison. Also Ethos is doing only a comparision on CO2 emision which is only one part of ESG.

Microloans would be riskier than ESG ETFs

[brice]

I thought I should mention an earlier post of mine on the topic: “What’s in the ESG sausage” .

As I explain there (“Properties the ETF’s index should have”), I have a hard time making sense of funds that try to compare MSCI ESG ratings across sectors or across geographical regions. I picked the UBS ones in the end.

[brice]

Interesting read. Its criticism is applicable to the screening part of the process and some other naive approach to SRI investing.

More rational approaches exists.

One I studied on my free time is centered on ESG risks (see my other post). This is the one MSCI takes, at least for some of their indices.

The short version: Investors should invest on the efficiency frontier, meaning they should only be exposed to compensated risk. Typically investors use past volatility as an example of compensated risk. Lack of diversification is an example of an uncompensated risk.

Providers of ESG ratings effectively argue that:

• Many ESG risks are uncompensated.
  I believe that to be true. If for example the company accountants doctored the books, then the share prices won’t reflect that. Same thing if IT hid a data leak (example: Equifax).
• ESG-based ETFs increase the discoverability of ESG risks, meaning companies must compensate investors to maintain their exposure (or more likely, reduce their exposure).
  That’s probably somewhat true, through the mandates that most ESG ETFs have as well as the economic incentives for index providers (example: BlackRock engaging with the HK stock exchange for more transparency).
• ESG ratings captures enough of the uncompensated ESG risk to make up for increased fees of the corresponding ETFs
  That’s the crux of the issue. If it’s true then ESG ratings are a quality factor and will remain so until enough companies have plans to properly manage their ESG risks (at which point ratings will be reflected in price and useless). If it’s false then it’s a cost that’s to put in the balance against increased discoverability of issues. I personally expect that the cost of the ETFs and risks of the methodology roughly cancel the benefits of reduced risk (which means that ETF providers priced it correctly) but preserves the benefit of discoverability for society.

I would be very curious of hearing of other rational approaches to SRI investing.

[hippo]

I find your write-ups and evaluations of ESG investing fascinating, especially the trade-off calculations on fees vs donating to charity.

My thoughts:

At a high level, I understand the objective of ESG investing is to dis-incentivise companies from engaging in unethical or unsustainable practices.

But if you are trying to capture the cost of doing so in this analysis you need to consider the actual effect your ESG investing has on the non-ESG companies. Essentially, considering what is the trade-off in buying one stock (ESG) vs another one (non-ESG).

When you are buying a stock in a company you are buying a share of its future cashflows. Unless you are buying at IPO directly from the company your cash investment goes straight into the pocket of a previous shareholder and does not directly benefit the company.

So what is the indirect added value to the company in having a slightly higher share price? It probably comes down to two key things which your read partly touches on:

• Easier/cheaper for the company to raise extra cash (both through equity financing or issuing bonds)
• Easier/cheaper to compensate employees/executives (through stock/option issuance)

How you evaluate the value of your investment to the company’s gain from the increase in share price is debatable, but I’d argue that the former is significantly greater.

One could argue that the most significant impact of engaging in ESG investing is that you are directly paying a premium to the non-virtuous (who benefit from your overweighting on ESG stocks), as well as paying a premium to the investment manager filtering according to ESG criteria.

Maybe a better use is to reclaim this premium and donate it through other means. Through donations you can even get the government (and maybe your company) to chip in a slice.