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ESG ETFs: Socially Responsible Investing Done Wrong

Written by Samuel Taube
Posted May 10, 2019 at 8:00PM

Americans collectively have more than $46 trillion in assets under professional management. And lately, we’ve been trying to invest it in a way that matches our values. Socially responsible investing strategies have become a big business for Wall Street in the last two decades.

$12 trillion — more than one out of every four managed investment dollars — is now tied up in some kind of socially responsible investing strategy (also known as an environmental, social, and governance, or ESG, investing strategy).

esg etfs. socially responsible investing, growth graphSources: US SIF Foundation, Penserra

And in the last few years, the ESG trend has merged with another trillion-dollar trend: the rise of exchange-traded funds (ETFs). The result has been an explosion of ESG ETFs. There are currently 182 of them on the market, almost a third of which were launched in 2018 or 2019.

On the face of it, this sounds like a good thing for the ESG investing world. After all, ETFs make obscure assets and complicated portfolios accessible to retail investors like you and me.

But these new ESG ETFs have a lot of problems, including high fees, subpar returns, and an inconsistent definition of socially responsible investing.

Today, we’re examining the subtle drawbacks of ESG ETF investing and discussing better places for socially responsible investors to park their money.

Feel-Good Fees

Cost is an issue for many ESG ETFs. Socially responsible equity funds are still seen as “luxury” investment products by many investors — and by many ETF issuers. They tend to carry higher expense ratios than most broad-market funds.

The average expense ratio of an ESG ETF is 0.42%, and some can run as high as 0.70%. While those fees aren’t outrageous, they’re considerably higher than those of many popular broad-market ETFs (which often charge investors less than a tenth of a percent).

Even Vanguard, king of the dirt-cheap funds, charges 0.12% for its domestic ESG ETF. That’s four times more expensive than its S&P 500 ETF.

It might seem like we’re splitting hairs over these expense ratios, but they do matter, as you can see from this Vanguard-produced chart:

esg etfs, socially responsible investing, vanguard cost graphSource: Vanguard

A difference of a few tenths of a percentage point can add up to tens of thousands of dollars in lost returns over a period of 30 years. ESG ETF expense ratios have fallen over the last decade, but they’re still high enough to merit concern from ESG investors.

And cost isn’t the only reason investors might be disappointed by ESG ETF returns...

Subpar Performance

ESG investing, as its name implies, puts an emphasis on social responsibility from an environmental, social, and governance perspective. But at the end of the day, it’s still investing. Not charity. The primary objective is to earn big returns.

Here at Wealth Daily, we believe it’s possible to invest in a way that’s both profitable and socially responsible (more on that in a moment). But the data clearly show that ESG ETFs aren’t the way to do it.

esg etfs, socially responsible investing, performance graph

A quick look at three of the most popular ESG ETFs — the iShares MSCI USA ESG Select ETF (NYSE: SUSA), the iShares MSCI KLD 400 Social ETF (NYSE: DSI), and the iShares MSCI ACWI Low Carbon Target ETF (NYSE: CRBN) — shows that ESG funds have trouble beating the market over multi-year periods.  

At this point we’ve established how many ESG ETFs overcharge investors for subpar returns. But at least they ensure that investors are giving their money to socially responsible companies and projects, right?

About that...

Inconsistent Definitions

“ESG investing” and “socially responsible investing” aren’t legal terms — their definitions are open to interpretation.

Herein lies a third problem with ESG ETFs: They often have conflicting definitions of ESG investments. One ETF might consider a given company to be very socially responsible and load up on its stock, while another might consider it to be morally tainted and avoid it.

One example of such a company is American Tower Corporation (NYSE: AMT). It has diametrically opposed ratings from two different ESG rating firms. One gives American Tower a top rating due to its favorable labor practices, while the other gives it a rock-bottom rating due to a perceived lack of transparency.

A Better Approach to Socially Responsible Investing

I didn’t write this article to bash ESG investing as a whole.

Quite the opposite, in fact. I wrote it to dissuade conscientious investors from choosing subpar investment products that might discourage them by failing to deliver competitive returns.

There are better socially responsible investments out there than the trendy ESG ETFs that have sprung up in recent years. I’m talking about individual ESG stocks.

I know, stock picking is hard work; it’s not for everyone. But it’s the best way to avoid the excessive fees charged by ESG fund managers and to beat the lukewarm returns they offer.

Are you a conscientious investor who wants big returns from carefully selected ESG stocks? Do you not have time to do the research yourself?

If so, check out Green Chip Stocks. Editor Jeff Siegel has earned subscribers dozens of triple-digit gains — and a few quadruple-digit gains — on companies that work hard to make the world a better place. Click here to learn more.  

Until next time,

Monica Savaglia

Samuel Taube

Samuel Taube brings years of experience researching ETFs, cryptocurrencies, muni bonds, value stocks, and more to Wealth Daily. He has been writing for investment newsletters since 2013 and has penned articles accurately predicting financial market reactions to Brexit, the election of Donald Trump, and more. Samuel holds a degree in economics from the University of Maryland, and his investment approach focuses on finding undervalued assets at every point in the business cycle and then reaping big returns when they recover. To learn more about Samuel, click here.

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