Sustainable investing is a popular buzzword on Wall Street these days. And while more and more investors are becoming interested in sustainable investing, many are not entirely sure what they are looking for or where to begin their search.
Part of the problem is the bevy of interchangeable terms often used: sustainability; environmental, social and governance (ESG); impact investing; and socially responsible investing. But investors are left asking what do these labels actually mean?
Add to that the issue that sustainable investing is very personal. Just as investors have unique goals and risk tolerances, they also have their own belief systems and issues they are passionate about. How can investors analyze mutual funds and exchange-traded funds (ETFs) to see whether a fund is investing in line with their beliefs?
This installment of Making the Grade discusses the topic of socially responsible investing and how you can use A+ Investor tools to identify socially responsible investments.
Historically, socially responsible investing was known mainly for “negative” screening, or excluding certain companies or sectors from a fund or portfolio. (Tobacco and oil stocks are two common examples.) Socially responsible investing now commonly includes “positive” screens as well—in other words, actively seeking companies or sectors considered to have “best-in-class” socially responsible performance metrics relative to their industry peers.
There’s been a longstanding perception that screening one’s portfolio can have a negative effect on investment performance, as it may result in less diversification. However, an increasing amount of research has countered this notion—particularly for funds that use both positive and negative screens, as opposed to negative screens alone. This was affirmed in a recent meta-analysis. Jon Hale of Morningstar reviewed the findings of numerous academic studies and concluded that socially responsible investors “can receive competitive performance while also addressing their sustainability concerns.”
Without a doubt, socially responsible investing is rapidly moving from a niche corner of the investment landscape into the mainstream. Additionally, the field has become quite broad in scope, encompassing not just screened funds but shareholder advocacy, community investment (deposits at banks, credit unions and other financial institutions whose mission is to serve low- and middle-income communities), as well as targeted “impact” investments in the private markets.
Until recently, much of the growth in socially responsible investing has been concentrated among large institutional investors. However, interest has been growing among individual investors—particularly women and millennials. The increased interest in socially responsible investing has dovetailed with another industry growth trend: index investing. Fortunately for socially responsible investors with a bias toward passive investment approaches, a growing number of options (particularly socially responsible ETFs) are becoming available.
Of course, socially responsible screens, which often rely on an added layer of internal or third-party research services, can still result in higher embedded fund expenses compared to their non-screened alternatives. But it is getting easier for index-oriented investors to build well-diversified socially responsible portfolios at a reasonable cost. Portfolio managers following such strategies seek out securities with both favorable socially responsible ratings and other attractive investment characteristics.
A+ Investor subscribers have access to predefined ETF (Socially Responsible Stock ETFs) and mutual fund (Socially Responsible Equity Stock Funds) screens that seek out funds classified as following a socially responsible approach to investing. Specifically, they seek socially responsible stock funds with low expense ratios and no loads. Passing mutual funds are also both open and available to individual investors.
A total of 28 ETFs and 27 mutual funds passed the screen as of March 31, 2021 (the screening data is updated monthly). Most are actively managed. The screens are available to A+ Investor subscribers at the respective Funds+ and ETF+ screeners.
In terms of relative performance, several of these funds realized higher returns than many of their peers over the last one- and three-year periods. This is indicated by A and B grades for three- and five-year annual returns. This suggests that it has been possible to do good while doing well. Careful selection is still required, as evidenced by poor one- and three-year returns for a number of funds. There is also a greater mix of funds than many investors might expect. Nearly half of the funds focus their investments overseas. There were also some small- and mid-cap funds passing these socially responsible fund screens.
From the 27 socially responsible mutual funds that passed the predefined Funds+ screen as of March 31, seven rate in the top 20% of their category in terms of net asset value (NAV) performance over the last three, five and 10 years. Here is the list ranked in descending order by 10-year return (you can sort on any column by selecting the up/down arrows next to the column head):
The Parnassus Endeavor fund (PARWX) ranks at the top of the socially responsible mutual funds that passed our filters.
Morningstar designates it as a U.S. equity (fund group), large value (category) fund. The fund has posted a 16.4% annual return over the last 10 years ending March 31, 2021, while gaining 98.6% over the 12 months ending in March.
Its 0.95% expense ratio is average among funds in its category (large value) and its risk index among its category peers is 1.23. This means it is 23% riskier than the typical large value fund, which is why it receives a risk grade of F.
According to the fund’s prospectus, the Parnassus Endeavor fund “normally invests at least 80% of its net assets (plus borrowings for investment purposes) in companies believed by the fund’s investment adviser to provide good workplaces for their employees. Companies with good workplaces usually are able to recruit and retain better employees and perform at a higher level than competitors in terms of innovation, productivity, customer loyalty and profitability. While no company is perfect, the adviser makes a judgment as to which companies have good workplaces based on factors such as respectful and fair treatment of employees, employee satisfaction and engagement, pay and benefits, family-friendly policies and support for volunteerism and philanthropy.”
Of the 23 ETFs passing the Socially Responsible Stock ETFs screen as of the end of March, two ranked in the top 20% in their category in terms of price return over the last three and five years. These ETFs are presented in the table below and are sorted from highest to lowest based on total 10-year performance:
The First Trust NASDAQ Clean Edge Green Energy Index ETF (QCLN) ranks at the top of the socially responsible ETFs that passed our filters.
Morningstar designates it as a sector equity (fund group), miscellaneous sector (category) ETF. The ETF has posted a 15.9% annual return over the last 10 years ending March 31, 2021, while gaining 241.6% over the 12 months ending in March.
Its 0.60% expense ratio is low among funds in its category (miscellaneous sector) and its risk index among its category peers is 1.20. This means it is 20% riskier than the typical miscellaneous sector ETF, but that still garners the ETF an A risk grade within its category.
According to First Trust, the objective of the ETF is to seek investment results that correspond generally to the price and yield of the NASDAQ Clean Edge Green Energy Index. The ETF’s prospectus states that the index “is designed to track the performance of clean energy companies that are publicly traded in the United States and includes companies engaged in manufacturing, development, distribution and installation of emerging clean-energy technologies including, but not limited to, solar photovoltaics, wind power, advanced batteries, fuel cells and electric vehicles.”
