Socially responsible ETF investing

Chef Martin Picard’s Au Pied de Cochon is my favourite Montreal restaurant. When I visited his maple sugar harvest event, it was a carnivore’s paradise — four meaty appetizers and three mains. But he also offered a vegetarian dish.

I tell you this because investment professionals tend to be carnivorous. Any investment with the scent of upside is fair game. But some investors don’t embrace traditional corporate values, and instead have social and environmental objectives. Today’s advisor should develop strategies to address those needs.

Socially responsible investing (SRI) used to mean “no tobacco, alcohol, gambling, weapons and no apartheid.” But sustainable environmental, social and corporate governance (ESG) activity has also become important. Some investors will exclude offending companies from their portfolios, while others prefer broader criteria, such as investing in best-in-class companies. So advisors will need to address these views.

The best way to construct a portfolio that meets a client’s social and investment needs is to build it from individual securities. A diversified solution may require more capital than is available, so a little imagination is required. Consider buying a broadly diversified ETF and shorting the objectionable holdings individually or collectively. One positive consequence is that you may reduce risk without impeding returns.

There are now ETFs that reflect the growing demand for responsible investments. There are five U.S. choices and one Canadian in the broad ESG category and several ecologically specific choices (see “Socially responsible ETFs in North America,” this page). Unique among these is the AdvisorShare Global Echo ETF that, in addition to seeking companies focused on sustainability in energy, technology and the environment, gives 0.40% per annum to Philippe Cousteau Jr.’s Global Echo Foundation.

The iShares Jantzi Social Index (XEN) excludes nuclear, tobacco and weapons manufacturers and holds 60 stocks that have been ranked for their environmental, social and governance criteria.

As of March 31, 2013, XEN had outperformed iShares S&P/TSX 60 Index Fund (XIU) for all periods with similar risk (see “Socially responsible ETF vs. broad equity indices,” this page). But this is a broad index that may not satisfy every investor interested in SRI, so you need to be creative.

XEN holds shares of Suncor, Imperial Oil, Cenovus Energy and Canadian Oil Sands — all oil sands participants. And yet consider the controversy over the Keystone XL pipeline. Critics are concerned about the potential for oil spills and the expansion of oil sands production. This is partly because average greenhouse gas emissions for oil sands extraction and upgrading are estimated to be between 3.2 to 4.5 times as intensive per barrel as for conventional oil produced in Canada or the U.S., according to the Pembina Institute.

To avoid holding those companies, one strategy is to buy XEN and short the iShares Oil Sands Index (CLO) in proportion to the approximate energy exposure (20%). In this way, you achieve broad ESG participation less oil sands exposure. The returns of this strategy are shown in the table “Tactic to establish,”.

Another tailored strategy is shorting the stock of an undesirable company while owning a SRI ETF that includes that stock. Some clients may be against a certain mining stock or object to a company operating in a war zone.

For instance, several public companies operate in the Sudan region, which is under sanctions for human rights violations. Such companies include Petrochina Company, the largest oil producer in China. PTR’s parent, China National Petroleum Corporation, helps the Sudanese explore and develop energy reserves.

Tactic to establish a Canadian non-oil sands SRI ETF portfolio

Socially responsible ETFs in North America

Tactic to establish a Canadian non-oil sands SRI ETF portfolio

A glossary of ETF terms

Underlying securities: Certain types of securities issued by corporations.

Net asset value (NAV): In mutual funds, the market value of a fund share; synonymous with bid price. NAV is calculated after the close of exchanges each day by taking the closing market value of all securities owned plus all other assets like cash, subtracting all liabilities, and then dividing the result by the number of shares outstanding — this last number can vary, depending on purchases and redemptions. This definition is specific to mutual funds.

Market price: Last reported price at which a fund was sold on the market. For any inactively traded security, evaluators have to determine a market price if needed. For ETFs, market makers look at the last prices and the depth of all securities in the basket of the fund to calculate its price.

Intraday value: Stocks can reach high or low prices, and then change value again, within the trading day. An ETF’s intraday value is its estimated fair value based on the most recent highest and lowest same-day price of its underlying assets. It is used to gauge the fund’s current market price against an intraday NAV estimate.

Bid-offer spread: The difference between a fund’s bid and offer prices. The two prices together comprise a quotation. For instance, if an ETF is trading at $15.30, market makers will set the spread at $15.29-to-$15.31 to show its highest bid and lowest offer. This is also know as the bid-ask spread.

Sources: Barron’s Dictionary of Finance and Investment Terms, Fifth edition; ProShares.com.

Mark Yamada is president and CEO of PUR Investing Inc., a portfolio manager specializing in disruptive strategies for investors, their advisors and pension plans. PUR is a registered portfolio manager.

Mark Yamada

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Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies.