A First socially responsible ETF takes unique approach-February 20, 2005

BOSTON- Socially responsible investors now have another investment vehicle for their toolboxes: an exchange-traded fund tracking an index of companies that score high on social and environmental ratings.

In late January, San Francisco-based ETF powerhouse Barclays Global Investors launched the iShares KLD Select Social Index Fund, the first socially responsible tradable fund. In its short history, the fund has attracted $20.5 million through Feb. 16, according to BGI.

The fund’s sponsors say it overcomes one of the biggest knocks on so-called green funds — that their aversion to sin stock industries such as tobacco, defense and energy leaves them overconcentrated in certain sectors, resulting in higher risk for investors. The iShares KLD Fund provides socially responsible investors with what we believe is a more thoughtful portfolio approach to optimizing positive social and environmental criteria while seeking to reduce sector risk, said Lee Kranefuss, head of intermediary business at BGI.

For example, socially responsible funds tend to favor growth and technology companies, so in the late 1990s it truly paid to be good. But the funds fell harder when the tech bubble popped in March 2000. More recently, the funds have lagged the market because they are generally underweight the energy sector, which has posted strong gains with oil prices rising dramatically.

Nuts and bolts

The ETF’s tracking index, which is managed by Boston-based KLD Research and Analytics, focuses on U.S. large-cap companies with positive social and environmental performance while attempting to maintain the risk and return characteristics of the Russell 1000 index. The KLD benchmark was introduced in June of 2004.

In the end, most socially responsible indexes make a ‘yes or no’ decision on companies, said Tom Kuh, managing director of KLD indexes. We look at factors like community relations, diversity, employee relations, human rights, product quality and safety, and corporate governance to overweight or underweight certain companies in the Russell 1000.

He said the goal of the index, which currently has about 300 companies, is to keep tracking error within 2 percent of the Russell 1000. The benchmark, however, does exclude tobacco companies outright.

As of Jan. 31, a sampling the top companies in the KLD Social Select Index included financial-services giant Wells Fargo, food producer General Mills and insurer St. Paul Travelers Companies. Investors will pay up slightly for access to the unique index. The ETF’s expense ratio is 0.50 percent of assets, while the Vanguard Calvert Social Index Fund and the TIAA-CREF Social Choice— both index funds — have fees of 0.25 percent and 0.27 percent.

Additionally, unlike no-load mutual funds, ETF investors must pay broker commissions to buy and sell shares. The iShares KLD Select Social Index also has proxy-voting guidelines in place that support sound corporate governance and responsible business practices.

The ETF generally supports proposals that call for more detailed reporting of a company’s social and environmental performance, as well as policies that are above and beyond regulatory minimums in the areas of environmental impact, governance, labor and community relations, said Lance Berg, a spokesman for BGI.

A wave of green

The new fund combines two of the strongest trends in investing today — the rise of exchange-traded funds and the growing popularity of social responsibility among everyday investors. Last year, ETF assets under management grew by about 50 percent to $226.2 billion, according to the Investment Company Institute, the fund industry’s main trade group. Meanwhile, in its 2003 survey of socially responsible investing (SRI), Washington-based Social Investment Forum said SRI assets in the United States were $2.1 trillion, up from $1.2 trillion in 1997. The group conducts its survey every two years One out of every nine investment dollars currently under professional management in the country is invested using some form of socially responsible criteria, said Elizabeth Laurienzo, a spokeswoman for Bethesda, Md.-headquartered SRI firm Calvert Group, which sells its funds through intermediaries.

SRI assets grew 40 percent faster than all professionally managed investments in the United States during the period 1995 to 2003, she added. However, of the over $2 trillion invested in socially responsible vehicles, which includes portfolios screened for particular stocks and sectors as well as separate accounts, only a small part of the pie is held in mutual funds.

According to Chicago-based investment research firm Morningstar, at the end of January there was $35.7 billion invested in 206 SRI funds. Nevertheless, the funds have been gaining steam with mainstream investors after the corporate shenanigans exposed at companies such as WorldCom, Enron and Tyco International.

The corporate scandals of the past few years have highlighted to investors the intangible value of companies that have strong governance and ethics, said Steve Falci, Calvert’s chief investment officer for equities. Still, the broad Calvert Social Index has lagged the S&P 500 index, slightly over the past three years, averaging annual gains of 3 percent through Feb. 17, compared with 4.6 percent for the S&P 500.

Yet SRI fund managers have benefited from the fact their investors generally take a long-term view and tend to be loyal to the funds. Right after the corporate scandals broke and the market was going down, there was a net influx of money into socially responsible funds, said Todd Larsen, a spokesman for Social Investment Forum. So they were holding their own and even gaining assets at a time when mutual funds as a whole were losing money.

And coming soon: clean-energy ETF

An ETF based on an index of publicly traded energy companies that focus on environmentally friendly sources of energy and technologies is set to begin trading on the American Stock Exchange next month under the symbol PBW.

The ETF, which will be managed by PowerShares Capital Management, will track the WilderHill Clean Energy Index, a benchmark calculated by the Amex that was launched in August. The Amex collaborated with index provider WilderShares LLC in developing the index.

The index contains 37 companies that use greener and renewable energy alternatives such as wind, solar and hydrogen fuel cells.