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“Sustainability” and “sustainable investing” are among the latest buzzwords in the exchange-traded funds (ETFs) industry. These funds cater to people who want to be certain that their money is invested in companies that are committed to environmental, social, and governance awareness. The sentiment has spawned its own acronym, ESG.

There are now nearly 70 ETFs that follow ESG principles, including a number of fixed-income funds.

One of the biggest socially conscious ETFs is the iShares MSCi KLD 400 Social ETF (DSI), with $3.3 billion in assets under management as of mid-October 2022.

Key Takeaways

  • ESG ETF is the unwieldy acronym for exchange-traded funds that invest in companies that operate responsibly in regard to environmental, social, and governance issues.
  • They avoid the stocks of companies that are polluters or exploiters.
  • As of late 2022, the three largest ESG ETFs included iShares ESG Aware MSCI USA ETF (ESGU), iShares MSCI USA SRI UCITS ETF (SUAS), and iShares ESG Aware MSCI EAFE ETF (ESGD).

Understanding DSI

DSI tracks the MSCI KLD 400 Social Index. “The MSCI KLD 400 Social Index is designed to provide exposure to companies with high MSCI ESG Ratings while excluding companies whose products may have negative social or environmental impacts,” according to MSCI. “It consists of 400 companies selected from the MSCI USA IMI Index, which includes large, mid, and small-cap U.S. companies. It aims to select companies with the highest ESG Ratings in each sector and maintain sector weights similar to those of the parent index.”

An important factor to be considered with DSI, or any sustainable fund for that matter, is that the companies and industries they exclude are as important as those they include. The underlying index used by DSI excludes stocks from some predictable industries, including alcohol, firearms, gambling, nuclear power, pornography, and tobacco.

Even with all those exclusions, DSI invests in 403 stocks and provides exposure to 11 industry sectors. Not surprisingly, the energy, materials, and utilities sectors have the smallest sector weights, adding up to under 15% of the fund’s portfolio.

The technology sector is a hallmark of sustainable funds, and DSI is no exception. Microsoft (MSFT), Alphabet GOOG, and Nvidia (NVDA) all are among its top 10 holdings, as is Tesla (TSLA). Other top holdings include Visa (V), Procter & Gamble (PG), Home Depot (HD), Abbievie (ABBV), and MasterCard (MA).

DSI Performance

You don’t have to give up profits to invest in ESG. A hypothetical $10,000 investment of $10,000 in DSI on Jan. 1, 2018, would have been worth about $20,900 at its peak at the start of 2022. In mid-October 2022, it was worth $15,034, still up by nearly 58%.

How Do I Know if an ETF Really Is ESG?

The ESG ETF industry has grown enough that there are people who rate them for their adherence to ESG principles as well as their profits. For example, the financial services firm VettaFi scores ETFs for their exposure to clean and not-so-clean technologies.

Are There Standards for ESG Investors to Follow?

Standards for ESG reporting by companies are still being developed. That means the investor is responsible for determining whether a company or an ETF is really following principles of environmental, social, and governance accountability as part of the decision-making process.

A number of institutions including the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are working on standards for companies to follow in reporting their ESG compliance.

Are There Sustainable Bonds?

Absolutely. The Nasdaq maintains a database of issuers of sustainable corporate bonds so that investors can choose to loan their money to companies that are investing it in clean technologies and environmentally-sound projects. The quasi-governmental housing agency Fannie Mae also offers “green bonds” and “social bonds.”

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