Daily Gains Letter

Four Ways to Ethically Beat the Broader Market

By for Daily Gains Letter |

250313_DL_whitefootIs there a place for morality in investing? Or does the end always justify the means?

When it comes to the stock market and wealth creation, there are two kinds of investors: those focused on making money at any cost; and those who will only invest in the kinds of companies that adhere to a particular world view, be it from a political, religious, and/or philosophical perspective.

Ethical, or socially responsible, investing traces back to the mid-1700s, when Methodism founder John Wesley told his followers, in his now famous sermon “The Use of Money,” how to conduct their business in the most ethical fashion possible. This included avoiding activities or financial transactions that might harm others. (Source: Wesley, J., “The Use of Money,” General Board of Global Ministries web site, last accessed March 22, 2013.)

Now, 300 years later, socially responsible investing is firmly entrenched in Wall Street. And it’s incredibly lucrative. Today, socially responsible investing has evolved into a $3.75-trillion industry. In 2011, socially responsible investing in the U.S. equaled the combined gross domestic product (GDP) of Brazil and Canada. (Source: “2012 Report on Sustainable and Responsible Investing Trends in the US,” The Forum for Sustainable and Responsible Investment, last accessed March 22, 2013.)

From 1995 to 2012, sustainable and responsible investing has grown at a compounded annual rate of 11%—1.2% faster than all professionally managed investment assets in the U.S.

Cumulatively, sustainable/ethical investing has increased 486% from 1995 to 2012; over the same period of time, assets under professional management in the U.S. have climbed 376%.

Over the years ethical investing has evolved from avoiding companies associated with guns, liquor, tobacco, and gambling to being more socially responsible, and investing in companies that promote environmental, health, and even political concerns. Among the top-10 socially responsible or ethical considerations are terrorist or repressive regimes, executive pay, tobacco, climate change, labor, and political contributions.

At the same time, there are investors with different concepts of what “ethical” or “socially responsible” mean and what this type of investing comprises. There are many shades to moral, ethical, and socially responsible investing. Some will only invest in particular stocks, while others are attracted to funds that invest in sustainability themes.

What follows is a list of funds that cater to socially responsible and ethical investors:

Pax MSCI EAFE ESG Index ETF (NYSEArca/EAPS) is an index that consists of equity securities of issuers organized or operating in developed markets around the world (excluding the U.S. and Canada) that have high sustainability or environmental, social, and governance ratings. The index has more than 60% of its assets in Europe, and it generated a 20% return in 2012. (Source: EGG Shares web site, last accessed March 22, 2013.) The exchange-traded fund (ETF) has an annual expense ratio of about 0.6% and has more than $24.0 million in assets under management.

iShares MSCI USA ESG Select Index (NYSEArca/KLD) tracks an index that scores U.S. large- and mid-cap stocks screened for positive environmental, social, governance, and ethics principles. The ETF excludes tobacco companies. It has an annual expense ratio of 0.5% percent and has more than $198 million in assets under management. (Source: iShares web site, last accessed March 22, 2013.)

The Iman K ETF adheres to Islamic principles, investing in Shariah-compliant companies. Islamic principles generally preclude investing in certain industries (i.e. alcohol, pornography, and gambling) and investments in interest-bearing debt obligations or businesses that derive a substantial amount of interest income. (Source: Iman Fund web site, last accessed March 22, 2013.)

The fund has an annual expense ratio of zero percent and more than $42.0 million in assets under management. In 2012, the fund returned approximately 13% and is up six percent year-to-date.

iShares MSCI Israel Cap Invest Mkt Index (NYSEArca/EIS) seeks investment results that correspond generally to the price and yield performance of the MSCI Israel Capped Investable Market Index. The fund has an expense ratio of 0.6% and has over $83.0 million in assets under management. (Source: iShares web site, last accessed March 22, 2013.)

In spite of the geopolitical tensions in the Middle East, Israel has a strong economy and an unemployment rate of just 6.5%.

As a lucrative, multi-trillion-dollar industry, it’s clear that there is a strong demand for socially responsible or ethical investments in the U.S. However, like the broader stock market, socially responsible funds operate better in some climates than others. Similarly, if you’re investing in socially responsible funds, it’s important to diversify.

In the end, no single fund that caters to virtue over vice can be in favor all the time.

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