An ETF for Positive Environmental, Social, and Governance Investing
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Environmental, social, and governance (ESG) investment strategies have experienced tremendous growth in recent years. In 1995, professionally managed investments in the United States that explicitly incorporated ESG criteria made up just $12 billion in total assets. In 2010, those ESG investments totaled $569 billion, a growth of 4,641%.
Despite that growth, most of it has occurred within the mutual fund space. Considering the popularity of exchange-traded funds, there are surprisingly few ESG ETF options to choose from. In 2010, ETFs made up only 1% of all professionally managed ESG investments. Surprisingly few options, however, does not mean there are none. And one of the largest ETF options for ESG investors is the iShares MSCI USA ESG Select Index (NYSEMKT: KLD).
The iShares MSCI USA ESG Select ETF’s underlying index is designed to give investors high exposure to companies that exhibit positive ESG criteria. These criteria include environmental, human rights, charity activity, management-labor relations, marketing practices, regulatory compliance, and corporate responsibility, among other similar criteria. Companies that have a high ESG ranking are given a higher weighting in the index, while companies that rank lower are given a lower weighting. Simple enough.
After all of the companies are properly ranked and weighted, this ESG ETF, with of over $200 million in total assets, gives investors a diversified fund with these two top holdings:
The industrial industry’s shining example
Eaton (NYSE: ETN) has consistently been recognized as one of the top socially-responsible large companies in the United States. It is a diversified manufacturer of a little of everything. Many of its products and technologies allow others to be more energy efficient and produce less pollution; from electrical distribution and hybrid power systems for commercial trucks to electric vehicle charging stations and components to make aircraft more fuel efficient.
If any company could be the poster child for socially-responsible investing, Eaton would be that company. In 2012, the company reduced its greenhouse gas emission by 19,000 metric tons, consumed 88 million less kilowatt hours of electricity, reduced its water usage by 2.6%, and generated 3,900 metric tons less of waste. The company's positive ESG measurements extend beyond the environment, as it also ranks high in employee and supplier gender and racial diversity, charitable contributions, management oversight, and generally being a good corporate citizen. It should be no surprise that Eaton is the iShares MSCI USA ESG Select ETF’s largest holding at 3.47%.
This 102-year-old company has transformed itself many times over the decades. Eaton is a much different company that it was even just 10 years ago. In 2002, the electrical business segment made up about 28% of sales. In 2012, however, thanks in large part to its recent acquisitions of Cooper Industries and two other companies, the electrical segment made up a whopping 60% of sales. Also during those past 10 years, Eaton significantly increased its presence in the aerospace industry through various other acquisitions. The company’s ability to change with the times has made it one the market’s more consistently strong performers.
North America’s largest green utility
Electric utilities are typically viewed as a necessary evil. We all need power, but of course none of us are too fond of large coal-burning plants spewing pollution into the atmosphere. That is not much of an issue for NextEra Energy (NYSE: NEE) though, as the cleanest electric utility in North America. NextEra is the largest wind energy producer in the United States, as well as the largest solar energy producer and generating 96.8% of its energy from renewables and other sources of clean energy.
In 2012, NextEra's clean energy mix generated 165,720 gigawatts power, 58.9% from clean-burning natural gas, 21.6% from nuclear, 15.1% from wind, 0.9% from hydroelectric, and 0.3% from solar. While claiming nuclear as “clean” can certainly be questionable (I am about a six-hour drive away from Fukushima, Japan), power generated from nuclear emits no greenhouse gases.
Because of this mix of clean sources of energy, NextEra Energy produces one of the industry’s lowest levels of greenhouse gas emissions; carbon dioxide emissions are 48% lower than the industry average, nitrogen oxide emissions are 77% lower, and sulfur dioxide emissions are 94% lower. And this will continue to decrease as the company demolishes old coal plants to replace them with new natural gas plants, as well as upgrade older power plants to make them cleaner and more efficient.
When all is said and done, being green can also be quite profitable. At the end of 2012, NextEra Energy's 10-year total returns were 228%. This easily beat the 99% total returns of the S&P 500 Index, as well as the 168% total returns of the S&P 500 Utilities Index. Making up 3.26% of the iShares MSCI USA ESG Select ETF, NextEra is a utility that many ESG investors would be happy to have in their portfolios.
Foolish bottom line
Investing strategies have changed a lot over the years. Fund managers today are more aware of environmental, social, and governance factors when valuing companies. The realization is that these ESG criteria are not just feel-good talking points, but a measurement of a company’s ability to generate long-term returns. If a company has a foresight to look past short-term quarterly results to do things like protect the environment, be socially conscious, and engage in good corporate governance, it is quite likely that company will still be around decades from now.
While that realization has not found its way to the ETF space as it has with mutual funds, the iShares MSCI USA ESG Select ETF is one of the best ways for investors to gain exposure to that long-term ESG investing strategy.
Matthew Luke has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!