If you are reading this article, you are likely interested in sustainable investing—aligning your investments with your values and making a positive impact with your portfolio. And you want to be smart about how you make your investment decisions.
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The most popular way to do this is with mutual funds and ETF’s (exchange traded funds) that consider a firm’s environmental, social and governance (ESG) scores in selecting their holdings.
Unfortunately, there are many potential pitfalls to this approach.
Traditional ESG scores are designed to measure the economic risk to a company resulting from operational considerations such as energy usage, labor practices and business ethics. They can allow for helpful comparisons between different firms within an industry, although the scores from the various major rating agencies can vary widely.
What may be most concerning is that these scores were not specifically designed to measure what many sustainable investors care about most—the risks to people and planet. There are also potentially great differences between fund managers in their approach to portfolio construction and shareholder advocacy. (See our article on the ESG Conundrum for more detail).
The following three tables compare two large ESG funds which at first appear to be very similar. They highlight the wide array of powerful data resources that can be used to uncover important differences and help investors make well-informed decisions in keeping with their values and goals.
The first fund is the iShares ESG Aware MSCI US ETF (ticker ESGU). It is perhaps the largest ESG fund in the U.S. iShares is owned by Blackrock, which is behind several major ESG funds. The second is the Calvert U.S. Large Cap Responsible Index (ticker CISIX). This is another large fund from an established industry leader (Calvert is now a subsidiary of Morgan Stanley).
The first table uses information from YCharts (a popular financial data aggregator) to illustrate how, despite a few differences, these funds have a great deal in common.
Both are large, established multi-billion dollar funds designed to track an index of large capitalization U.S. stocks that score well on ESG metrics.
While they have similar holdings, the Calvert fund has less overlap among its largest 15 holdings with the those of the S&P 500 index, and has a modestly heavier growth and small company orientation than the iShares fund.
They both have low expenses, low turnover and similar yields and returns. Both receive the same top ESG rating from MSCI and have strong positive momentum in their ESG scores.
| Table 1. Fund Overview (Ycharts) | ||
|---|---|---|
| As of 9.1.22 | iShares (ESGU) | Calvert (CISIX) |
| ESG Aware | US Large Cap | |
| E.S. ETF | Resp Index | |
| (ESGU) | (CISIX) | |
| Investment Style | iShares (ESGU) | Calvert (CISIX) |
| Category | US Lg Blend | US Lg Blend |
| Growth-Value % | 18% | 22% |
| Small & Mid Cap % | 20% | 26% |
| Top 15 S&P in Top 15 | 87% | 60% |
| Key Operating Statistics | iShares (ESGU) | Calvert (CISIX) |
| Fund Size ($billions) | 22.2 | 3.9 |
| Expenses | 0.15% | 0.24% |
| Turnover | 21% | 10% |
| Yield | 1.39% | 0.97% |
| 5 Yr. Cumulative Return | 74.8% | 76.2% |
The next table introduces data from Morningstar and As You Sow, long-time leaders, respectively, in the fields of providing information on mutual funds and engaging in shareholder activism.
This comparison data begins to identify key differences between the funds. While both funds earn the second highest sustainability rating from Morningstar (4 globes), the Calvert fund scores higher on risk adjusted returns.
A more dramatic difference is that the Calvert Fund has less than 1/3 the fossil fuel industry exposure of the iShares fund which has significant holdings in companies such as Exxon and Chevron.
| Table 2. Digging Deeper (Morningstar & As You Sow) | ||
|---|---|---|
| Fund Ratings (Morningstar) | iShares (ESGU) | Calvert (CISIX) |
| Globes (sustainability) | 4 | 4 |
| Stars (risk adjusted return) | 4 | 5 |
| Fossil Fuel Involvmenet | 6.15% | 1.84% |
| Industry Grades (As You Sow) | iShares (ESGU) | Calvert (CISIX) |
| Carbon | D | B |
| Forests | D | A+ |
| Gender | A | B |
| Civilian Firearms | A | B |
| Prisons | D | C |
| Weapons | D | B |
| Tobacco | B | B |
This leads to a dramatically different fossil fuel free ratings from the “Invest your Values” tool provided by As You Sow, which gives iShares a D grade and Calvert a B.
Calvert also scores significantly better for having less exposure to companies involved with deforestation and military weapons.
The As You Sow industry information indicates the degree to which potentially offensive or harmful activities are excluded from a portfolio. This is often referred to as negative screening or socially responsible investing (SRI).
The final table highlights some of the biggest differences between the funds. It includes proxy voting information from the transparency tool on the Calvert website, as well as impact scores from next-gen data providers YourStake and Ethos ESG which focus on risks to people and planet (as opposed to company stock price).
The proxy voting record highlights a stark difference between the two funds, with Calvert typically voting with shareholders and iShares generally siding with management.
| Table 3. The Big Differences (calvert, YourStake, Ethos) | ||
|---|---|---|
| Proxy Voting (Calvert website) | iShares (ESGU) | Calvert (CISIX) |
| Vote with Shareholders | 22% | 87% |
| Vote Against Mgt | 4% | 26% |
| Relative Impact Scores (YourStake) | iShares (ESGU) | Calvert (CISIX) |
| Health | 30% | |
| Environment | 73% | |
| Human Rights | 8% | |
| Equal Opportunity | 52% | |
| Accountability | 4% | |
| Overall Scores (Ethos) | iShares (ESGU) | Calvert (CISIX) |
| Impact Rating | B (65) | A (93) |
| Advocacy Rating | C | A |
Unlike traditional ESG rating services which depend largely on voluntary reporting by companies being rated, YourStake looks to data from government sources, regulators, academic research and trusted NGO’s (non-governmental organizations).
They consider dozens of data series such as air and water pollution (health), fossil fuel, clean energy, and single use plastic production (environment), forced labor and arbitration (human rights), and gender equity and compensation scales (equal opportunity).
Their summary scoring system indicates the % by which one fund or portfolio outscores another on five major impact themes.
Ethos tracks 280 ESG metrics on over 13,000 securities, and organizes this data by various causes, including the U.N. Sustainable Development Goals.
It also provides a summary output, which boils down to two scores: one for impact and one for advocacy. These overall ratings from Ethos provide a very helpful recap (currently available as a free online service).
Many ESG investments are not all that they appear to be, which is why making good socially responsible investment decisions is not a simple task.
Access to high-quality data is essential. We presented information from six different data providers. Most of the information provided above is either not available to the public or requires a paid subscription for full access. But it’s not just the raw data, it is also knowing which pieces of information are most valuable and how to put them together.
This underscores the value of working with an expert advisor, such as Colorado Capital Management, to help you with constructing your portfolio and making a difference. We are passionate about investing for impact and would be happy to assist you on this journey.
Contact us to schedule an introductory appointment.
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