I often get asked what I think about funds that invest with an environmental and socially responsible mandate. I understand the desire to effect change through the choices we make. Environmental considerations drive many of my decisions, such as living within walking distance to work, buying just enough home, choosing leisure activities that do not require driving and avoiding air travel as much as I reasonably can.
Fortunately, frugality and environmentalism align quite well. But what if they don’t? I’m willing to pay a premium for groceries with less packaging but would I be willing to have a less secure retirement? It depends on the extent of this sacrifice and the difference that it could make.
Let’s take a look at two comparable portfolios, one made up of funds with an environmentally and socially responsible mandate and the other of vanilla total market ETFs. I will assume that both are 20% Canadian equity, 36% US equity, 20% international equity (developed markets), 4% emerging markets and 20% Canadian bonds.
Ethical portfolio of ETFs
- Canadian Equity: iShares Jantzi Social Index ETF (XEN)
- US Equity: iShares ESG MSCI USA Index ETF (XESG)
- International (developed markets): iShares ESG MSCI EAFE Index ETF (XSEA)
- Emerging Markets: iShares ESG MSCI Emerging Markets Index ETF
- Canadian Bonds: iShares ESG Canadian Aggregate Bond (XSAB)
Total market portfolio of ETFs
- Canadian Equity: iShares Core S&P/TSX Capped Composite Index ETF (XIC)
- US Equity: iShares Core S&P U.S. Total Market Index ETF (XUU)
- International (developed markets): iShares Core MSCI EAFE IMI Index ETF (XEF)
- Emerging Markets: iShares Core MSCI Emerging Markets IMI Index ETF (XEC)
- Canadian Bonds: iShares Core Canadian Bond Universe ETF (XBB)
The fees (MERs) are higher for the ethical portfolio (0.36% vs. 0.14%). Is that a big deal? Assuming you invested $10,000 a year and earned a 5% real return per year, 0.22% would cost:
- $1,300 after 10 years
- $7,600 after 20 years
- $24,600 after 30 years
- $62,900 after 40 years
- $142,500 after 50 years
Now, you could more than make up the difference by simply saving a bit more. Whether it’s worth it is up to you.
The ethical portfolio is less diversified with 1,399 holdings vs 10,308 for the total market portfolio. That means it is more sensitive to the failures of individuals companies. This risk is hard to quantify. But it is a clear negative and not something that you can protect yourself against by simply saving a bit more.
Will your investment dollars make a difference?
The total value of the global stock market is roughly $80 trillion dollars, and around half of that is controlled by large pension funds. These institutions have a fiduciary duty to seek the maximum return possible for their members. Most of the rest is controlled by insurance companies and individuals who will also seek to maximize their returns.
If there is a profitable investment out there, it will attract the dollars it needs. You will not deprive these businesses of the capital they require to operate.
Are these funds really socially responsible?
Let’s play a little game. Out of the list of companies below, try to pick which the ones that are in the environmentally and socially responsible iShares ESG MSCI USA Index ETF and which ones are not:
- Johnson & Johnson
- Nexetra Energy
- JPMorgan Chase
- Walt Disney
- Honeywell International
- Exxon Mobil
- General Mills
- General Electric
- Kinder Morgan
The environmentally and socially responsible fund holds all of these companies. Do they fit your views of environmentally and socially responsible? If not, you should think long and hard about whether this fund and others like it are worth the higher fees and the less diversification.
But wait! Surely the environmentally and socially responsible portfolio will outperform the total market. The future is clean energy, not oil.
Maybe, but companies re-invent themselves all the time. Amazon used to only sell books, American Express used to deliver mail on horseback, Nintendo used to run a chain of hourly hotels, Netflix was a DVD rental company, Shell specialized in…decorative shells.
It’s impossible to predict which companies will gain the most from a transition to a cleaner economy. What if Exxon Mobil decides to use its vast resources to become the world leader in clean energy? Actually, that would be perfectly fine…the ethical portfolio above already invests in Exxon Mobil.
Honestly, these ethical funds are more of a mess than I expected. From the higher fees, less diversification and questionable holdings, I would not invest in them.
I’m sure they will get better with time. But even then, I’m not convinced that your investment decisions are an effective way to make a difference.
I will continue to focus my environmental efforts on other areas of my life: where I live, how much I drive, what I consume and how I vote. For my retirement portfolio, I will continue to just buy the world.