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ETF-INVESTMENT

Sustainable and moral investing with ETFs

by Max

The world is in a state of flux. News of devastating forest fires and crisis areas are piling up. In addition, corruption is preventing social advancement of entire countries.

We have to ask ourselves how we can take a path to confront and counteract climate change and morally questionable structures. We can do this not only through actions in our everyday lives, but also with our investments.

Currently, a variety of ETFs are coming to market with the label "sustainable." The two best-known labels here are certainly "ESG" (Environmental, Social and Governance) and "SRI" (Socially Responsible Investing). But what is behind these labels and do they deliver what they promise? In this article I will introduce you to the topic of sustainable and moral investing with ETFs.

ESG and SRI Indices

ESG: Behind the label "ESG" or also "ESG Screened" is an index on a specific market that excludes stocks that do not meet certain specifications in the environmental (e.g. pollution, scarce natural resources), social (e.g. labor issues, data security) and corporate governance (e.g. unethical business practices) areas. In addition, the index should not include companies that make their money from firearms, nuclear weapons or tobacco.

The MSCI World ESG Screened Index currently includes 1,498 companies. The MSCI World, on the other hand, contains 1,600 positions. Perhaps this is where your first doubts arise as to how sustainable such an ETF can be, which only differs from its big brother by just under 100 companies. The following label is more consistent.

SRI: An SRI ETF is committed to "socially responsible investing". An SRI ETF goes a few steps further and tightens the ESG guidelines. Here, it additionally excludes companies that are home to military equipment, alcohol, adult entertainment, gambling, and genetic engineering, among others.

The MSCI World SRI Index now includes only 385 companies. That's just a quarter of the MSCI World. Even a company like Apple no longer finds a place in the stricter version.

Comparison of returns

Since we do not only want to use our money for world peace, but also to achieve the best possible return, we now take a look at the performance of the MSCI World Index compared to the MSCI World SRI.

Over a 10-year period, the MSCI World has returned an average of 10.81% per year, while the MSCI World SRI has returned an average of 11.32% per year (source: www.msci.com). Thus, the sustainable little brother even beats the world index by a narrow margin. Of course, looking back cannot promise the future, but your worries about returns should be alleviated.

Criticism of such sustainable ETFs

What is misleading about the labels is that each provider may apply different sustainability criteria and that there is no agreement on how exactly to map an ETF in terms of ESG and SRI indices. It is understandable that an assessment of social and environmental benchmarks depends on subjective factors, so even given criteria may be assessed differently. But this certainly does not make it easier for the private investor.

Let me give you an example. The little industrious vacuuming robot that keeps your apartment free of dirt while you are at work may be equipped with sensors and software from the military industry (source: die Welt of 12.07.2018: "Did you know that your robot vacuums with military technology?"). Now, how should we consider the robot vacuuming company under SRI criteria that do not want to allow military equipment? You can see that it is quite difficult to come to a common denominator here.

In addition, some suppliers use the "Best in Class" principle. This principle can be described as filtering out companies from each sector that are leaders in terms of sustainable business practices when it comes to implementing the criteria mentioned. But how sustainable is the most sustainable arms export company?

Conclusion

In conclusion, we should not make the mistake of reflexively drifting into the popular phenomenon of "whataboutism." We only have this one world to leave to our children. Every step in the right direction is an important one.

Moreover, the criteria are constantly being tightened, improved and made more transparent. The more investors switch to the sustainable variants, the faster the development of these indices and ETFs will proceed. Even if we still have to accept many a company that does not yet fully meet the criteria.

The development towards more sustainability is progressing and must be supported. For example, there is the further labeling "ESG Trend Leaders" for ETFs that include companies that do not currently have a good sustainable rating, but which show a strong trend towards sustainability.

Companies are also somewhat interested in being included in large ETFs, as this requires their shares to be purchased by ETF providers. Now, if the trend towards sustainable ETFs intensifies, companies will be pushed to become more sustainable in order to get into the ETFs described above. And who knows, maybe in the future we won't need the ESG or SRI labels at all, as all companies will be doing their part to create a more sustainable world. It would be desirable.

Kind regards and a happy holiday season

Max from maxximieren