Investing in Virtue Is Hard When So Few Companies Measure Up

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(Bloomberg Gadfly) -- It’s not easy being a socially conscious investor. To see why, look no further than Facebook Inc.

By any reasonable ethical standard, the social media giant doesn’t measure up. The Cambridge Analytica debacle and its aftermath revealed that Facebook is collecting far more information on its users -- and even non-users -- than it let on. And, as my colleague Shira Ovide pointed out, when CEO Mark Zuckerberg had the opportunity to come clean last week during two days of congressional testimony, he ducked questions about how the company operates.

Facebook’s wily ways appear to be catching up to it. According to a March 21-23 Reuters/Ipsos poll, only 41 percent of Americans “trust Facebook to obey laws that protect their personal information.” An April 8-9 SurveyMonkey/Recode poll asked respondents which technology company they least trust with their personal information among Amazon, Apple, Facebook, Google, Lyft, Microsoft, Netflix, Tesla, Twitter, Snap and Uber, and 56 percent chose Facebook. The runner-up was Google, with just 5 percent.  

Given all the questions surrounding Facebook, investors may be surprised to learn that its stock is commonly held by so-called socially responsible funds, which invest in companies deemed to be good citizens.

The biggest such exchange-traded fund -- the iShares MSCI KLD 400 Social ETF, with $1 billion in assets -- bills itself as an “exposure to socially responsible U.S. companies” and urges investors to use the fund to “invest based on your personal values.” The fund has a 3.5 percent allocation to Facebook.

Facebook is also among the stocks held by the second-largest socially responsible ETF, the iShares MSCI USA ESG Select ETF, with $679 million in assets. The fund holds roughly 100 large- and mid-cap stocks “screened for positive environmental, social, and governance characteristics.” Facebook accounts for only 0.09 percent of the fund, but it’s sobering to think that there isn’t a worthier company among the hundreds of candidates. 

So how does Facebook make the cut? It turns out that socially responsible investing isn’t necessarily just about picking the most virtuous companies. MSCI Inc., for example, looks for industry specific environmental, social and governance policies that have historically made money for investors. The idea is to simultaneously invest in responsible companies and beat or match the return of the broader market.

And MSCI has delivered. The MSCI KLD 400 Social Index has beaten the S&P 500 Index by 0.5 percentage points annually from May 1990 to March 2018, including dividends -- the longest period for which returns are available. The MSCI USA ESG Select Index has trailed the S&P 500 by just 0.2 percentage points since June 2004.

But doing good and making money don’t always fit neatly together. By focusing on socially responsible behavior that’s been lucrative, investors risk overlooking other socially desirable behavior that hasn’t -- or worse, overlooking bad behavior. Facebook is just one example.

Many socially responsible funds are dominated by technology stocks. Tech is by far the most represented sector in the two iShares ETFs, with a 32.8 percent allocation in the KLD 400 Social ETF and a 28.2 percent allocation in the ESG Select ETF.

One reason that tech is so prominent is that the sector has a low carbon footprint, so it scores highly in environmental screens. But social responsibility screens also don’t account for troubling aspects of the sector and some of its biggest companies. That includes Facebook’s questionable privacy policies, concerns that Apple’s products are taking a toll on public health, the vulnerability of Google’s advertising network to misuse and widespread accusations of sexual harassment in Silicon Valley.   

Deciphering the good companies from the bad is hard enough without having to think about making money. Consider that RobecoSAM -- one of several firms that grade companies based on various social responsibility metrics -- gives Facebook a “total sustainability rank” of 41 out of 100. Sustainalytics grades Facebook more highly, giving the company an “ESG rank” of 62 percent, which puts it in the top half of peers. And ISS thinks far less of Facebook, giving the company a “governance quickscore” of 10, the lowest score on a 10-point scale.  

The confusion around socially responsible investing may be a reason it isn’t more popular. Yes, socially responsible ETFs took in a record $1.3 billion in 2017, but that accounted for only 0.3 percent of ETF flows, according to Bloomberg Intelligence. That’s down from a high of 0.8 percent in 2006.

Socially responsible investing may be a worthy goal, but it’s no panacea. Investors who are serious about it may have to decide which comes first: doing well or doing good.

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

©2018 Bloomberg L.P.

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