Socially responsible investing (SRI) and environmental, social and governance (ESG) investing has become two of the most discussed topics in the investment industry lately. There is often a misbelief that when you invest in SRI products you sacrifice performance and yield, but this is not always the case. If fact, year to date the SRI indices have outperformed the main parent indices – a similar picture to the three years annualised figures, except for Japan which has underperformed the main index.
One of the vehicles of choice for investors wanting to ‘invest for good’ are exchange traded funds (ETFs). ETFs are transparent, which means investors can see exactly what companies they are investing in at any time. These low-cost products typically have a higher total expense ratio than their main parent index counterparts.
Performance of MSCI SRI indices versus parent
It is difficult for a passive rules-based index to cover every investor’s “ethical wish list” as it is impossible to outsource an individual’s moral to an investment manager. However, the majority of the funds provide options that can go some way to satisfy an individual’s ethical goals.
There are gaps, however. For example, while there has been a whole range of products launched that track equities there is still a lack of fixed income products.
ESG/SRI methodologies differ
Most European ETF providers are launching products but they are all tracking an index which has different ESG/SRI methodologies.
Products from iShares and UBS each use the MSCI SRI indices and have built up a good amount of assets under management in their equity products. However, there is a difference between them as UBS ETFs use the MSCI index which has a maximum weight of 5% cap on any individual holding and this can make quite a difference in performance returns. The uncapped index can allocate a high weighting to individual stocks.
These indices start by taking the main parent index such as the MSCI World and then remove stocks that are not consistent with a given set of SRI principles, a process called “negative screening” – this screening can differ drastically across providers. Most will exclude tobacco producer companies but at what point do they exclude companies that are involved in production, distribution, retail and supply of tobacco-related products such as the makers of cigarette packets or tobacco retailers like J Sainsbury?
The MSCI SRI Indices methodology excludes most of what investors might view as “sin stocks” like controversial weapons companies, producers of civilian firearms for civilian markets, tobacco producers, alcohol production companies etc. However, the methodology may allow for some companies to be included depending on their percentage of revenue from these type of business activities.
Country weights differ from parent indices
The MSCI indices aim is to be sector neutral to the main parent index so all sectors are included – although there are some large differences in country weights, particularly in emerging markets products – most notably China.
SRI and ESG methodologies differ across index providers and, as with any investment product, it is important for investors to understand what they are buying. This includes analysis of any index the ETF is tracking.
