Socially Responsible Exchange Traded Mutual Funds
ZoŽ Van Schyndel, CFA, StarFish Financial Consulting Services
Socially responsible investors in Europe will soon have a choice of two new exchange-traded fund (ETF) products. Now is the time for US investors to demand the same easy access to US markets. Paris-based Axa, Europe's second-largest insurer, and Intesa SpA have either recently launched or indicated that they will start up ETF’s that cater to the growing number of Europeans who demand their money is invested socially responsibly. ETF’s are mutual funds that are traded on exchanges just like stocks and have become very popular due to the growth in demand for index linked products, their tax efficiency, low cost, and ease of trading.
Both FTSE and Dow Jones are creating socially responsible investment (SRI) focused ETF’s to carve a niche in the U.S. market. In early November, FTSE announced a joint effort with the American Stock Exchange (Amex) to introduce exchange-traded funds (ETFs) based on FTSE4Good indexes. Dow Jones has also indicated that they have a licensee for an exchange-traded fund based on the Dow Jones Sustainability Indexes. If all of these products are launched US social investors will finally have ETF options where they have none today.
Why would US social investors be offered this mainstream financial product now? The largest players in ETF’s, BGI, The Bank of New York, and State Street Global Advisors (SSgA) have saturated the ETF market with products from real estate to fixed income. These firms are now looking to cover any niches missing from their lineup and one of the largest holes is SRI. A SRI ETF would fill this void quite nicely and is just the thing that today’s post Enron marketplace needs.
Mainstream financial institutions have developed and added screened or values based investment products to their market offerings at an unprecedented rate over the past few years. These firms are seeking to add to their stable of products and a SRI ETF is just one more example of how big this market is becoming. Social investors are also looking for products that will allow them to invest using the same range of strategies for socially responsible investing that are available to them in "traditional" investing.
Since KLD Research & Analytics introduced the Domini 400 Index in 1990, social indices and mutual funds that track them have proliferated. The Domini Social Equity Fund appeared in 1991, followed by social indexes from Dow Jones, FTSE, and Calvert. In 2001, the UK-based stock market index FTSE launched four indexes, including two that list only U.S. companies. A measure of the success of these various indexes is indicated by the Dow Jones sustainability indexes, which alone have more than 30 licensing arrangements for financial products.
There are now four social funds with over $1 billion in assets. Fund offerings currently run the spectrum from diversified market tracking large cap products to more specialized niche products such as the Parnassus CA Tax Free Fund. Even though the number of mutual fund choices for social investors has grown to several hundred, the range of SRI products still does not compare to those available to mainstream investors. As the SRI market becomes more sophisticated these investors will demand targeted investment products that meet their particular needs.
Although retail social investors currently have a number of index tracking investing options there are still some holes in the product lineup. Until now retail SRI investors did not have a socially responsible ETF that they could invest in or a futures contracts or options with which to gain exposure to the market. An ETF provides a highly liquid, tax efficient vehicle with which to gain access to a large piece of the market at a relatively low cost. All of these features make a socially responsible ETF very attractive to individuals with limited funds with which to invest or for those who seek instant exposure to the market.
On the institutional side many SRI mutual funds permit their portfolio manager to invest the funds excess cash in S&P 500 futures contracts. Although this investment contract provides exposure to the market it is access at a price, as not all 500 stocks of the S&P 500 would pass muster for SRI investors. A socially responsible ETF would provide institutional investors with a quick and efficient method to equitize cash in their SRI portfolios.
BGI launched a series of fixed income ETF’s at the end of July in 2002 which already have several billion invested in these funds. When a fixed income SRI ETF product is launched social investors will have the ability to create a balanced account with a few trades. As other SRI products targeted at mainstream investors are brought to the market SRI investors will be able to more closely tailor their portfolio and investment product selections with their values. Additional options to invest also means that the market will become increasingly segmented and SRI index providers will have to be more creative in their offerings.
The future for SRI investable index products will be a world where investment universes are customized so that the needs of SRI niches both big and small are met. Coming soon to a marketplace near you will be a socially responsible index product targeted at seniors and which highlights ethical drug manufacturers along with companies that have good pension plan benefits. When mainstream investors have over 50,000 indexes from which to choose and SRI investors have roughly 100 there is enough room within which index creators can provide new products for the socially responsible investor.
With SRI assets of over $2 trillion, according to the Social Investment Forum’s “2001 Report on Responsible Investing Trends in the US, there is a market that is large and yet diverse enough to require innovative product offerings. The SRI index product options are vast and limited only by investor demand and the ability of financial service organizations to package products to meet that demand. The US has allowed Europe to take the lead on innovative financial products for socially responsible investors. It is high time for the financial service firms to provide US investors an ETF option to put their money where their values lie.