Socially Responsible ETFs
Socially responsible exchange-traded funds (ETFs) give investors a way to invest in issues that are important to them. These ETFs often incorporate environmental, social, and governance considerations into their investment approach.
What are socially responsible ETFs?
Socially responsible ETFs are a bundle of assets available for trading that place special consideration towards environmental, social, and governance factors to align with values of investors.
Common approaches to SRI include:
This approach, also called negative screening, focuses on excluding certain companies, such as those that derive revenues from alcohol, tobacco, or firearms, from a portfolio. It appeals most strongly to investors who want to avoid investing in companies that don't align with their values.
An integration approach attempts to improve the portfolio's risk/return profile by considering ESG risks and opportunities in the investment strategy along with other material factors. In this approach, portfolios are constructed by investing in companies that score well on material ESG issues that are important to a specific sector.
This approach refers to explicitly deploying investment dollars in an effort to directly achieve a measurable outcome. Impact investors are typically interested in making a difference in the world or environment through the companies in which they invest.
Typical investment portfolio exclusions from SRI portfolios include tobacco, alcohol, gambling, and weapons.1
Common approaches to ESG integration and impact investing, targeting companies that are doing "good," include:
- Climate change: Investing in companies that are fighting climate change.
- Natural resources: Investing in companies that are preserving clean air and water, promoting responsible forestry, etc.
- Pollution and waste: Investing in companies that are reducing or eliminating pollution and waste.
- Human capital: Investing in companies that are hiring and training disadvantaged populations.
- Corporate governance: Investing in companies with strong governance, such as clean accounting.
If you're an investor who's interested in incorporating ESG issues into your portfolio, SRI can be an attractive investment strategy. As you should with non-SRI investments, you should consider the quality of the ETF—its costs, risks, performance potential, and the experience of the investment team. Then you should consider how the investment aligns with your SRI preferences by further examining the ETF's holdings.
View a list of socially responsible funds available at Schwab.
What are the pros and cons of socially responsible ETFs?
As you make decisions about your portfolio, it’s important to understand what socially responsible ETFs can offer and what to watch out for.
As is the case with any ETF, socially responsible ETFs can help diversify an investment portfolio when mixed with other asset classes.
Broad array of investments.
Socially responsible ETFs are available in over 25 Morningstar categories, but the majority are in equity asset classes, such as domestic, international, and sector equity.
Since most ETFs provide daily disclosure of their holdings, investors are able to see exactly which securities are held by the ETF each day. This enables investors to align their investments with their socially responsible preferences.
Lack of customization.
Investors often do not have the ability to customize an ETF's portfolio holdings to exclude securities that may conflict with their values.
Limited fixed income options.
While fixed income is a growing asset class for SRI, fixed income ETF choices remain more limited than equity asset class choices.
As the investing public has grown more interested in SRI, some money managers have begun to talk about SRI aspects of investment strategies that formerly were not described in those terms. In some cases, the degree of SRI incorporation in the ETF is minimal. The practice of exaggerating the SRI aspects of an investment strategy is known as "greenwashing." Signs that indicate an SRI investment strategy may be greenwashed include:
- Very weak references to SRI factors in the ETF's investment objective and description.
- An ETF that had no references to SRI in recent years suddenly has SRI terminology added to the fund documentation or prospectus.
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