Morningstar Advisor - June/July 2009 - 33

The magazine of investing insights for independent-minded advisors February/March 2009 Morningstar Advisor Two SRI ETFs Are Solid Core Choices By John Gabriel Exchange-traded fund investors looking to invest with a socially responsible tilt have a couple of core choices: iShares KLD 400 Social DSI and iShares KLD Select Social KLD, both of which levy expense ratios of 50 basis points. Both are secular SRI funds that could be considered core holdings for large-cap equity exposure. They employ sector constraints to ensure tight correlation with the S&P 500 Index. In fact, over the past two years, the ETFs have displayed 99% correlation with the S&P 500, despite the fact that only 48% and 56% of the S&P 500’s holdings are included in DSI and KLD, respectively. The funds’ mandate to mimic the performance of the broader market means that investors could use these funds in place of large-cap funds such as SPDRs SPY and iShares Russell 100 IWB. There are two important points, however, to consider when deciding between these two SRI ETFs. The first is determining how adamant the investor is about investing in a socially responsible manner. For the diehard socially responsible investor, DSI would be preferable over KLD because of its stricter social criteria. Right off the bat, DSI excludes any firm involved in tobacco, alcohol, gambling, firearms, military weapons, and nuclear power. It then selects companies with positive records on the environment, climate change, human rights, diversity, and executive compensation. On the other hand, KLD ranks all of the stocks in the S&P 900 Index (excluding only tobacco companies) based on KLD’s proprietary scoring system and weights them according to their scores. (Companies with high ratings should have a higher representation in the underlying index than they do in the S&P 900 The magazine of investing insights for independent-minded advisors Summer 2008 The Only Safe Bet Is Risk Index, and vice versa.) The system then screens the index for companies with positive environmental, To be surprised by the recent meltdown is to ignore the volatile history of capital markets. social and governance performance relative to their industry and sector peers, and in relation to the broader market. MorningstarAdvisor.com Financial Crisis Mandelbrot, Cooper, and Ibbotson Greenspring February/March 2009 Thus, KLD’s portfolio includes the likes of Chevron CVX, General Electric GE, and Goldman Sachs GS (albeit at lower weights relative to the market). None of these firms is present in DSI’s portfolio. In short, DSI only selects firms that it deems to be socially responsible, whereas KLD simply uses social and environmental factors to increase or decrease a company’s weighting. This brings us to our second major deciding factor: the investor’s thesis on the energy sector. Because of its stricter index construction rules, DSI is extremely underweight in energy. If energy prices recover over the next couple of years, then DSI would likely lag the broader market. Investors who are bullish on energy but still wish to invest in a socially responsible manner should select KLD. Would-be investors should also weigh their desire to be socially responsible against their financial objectives. The SPDRs and iShares S&P 500 IVV are two non-SRI funds that mimic the S&P 500 that can be had for 8 basis points per year. At the end of the day, it boils down to whether or not investors are willing to pay a 42-basis-point SRI premium for similar performance. John Gabriel is an ETF analyst with Morningstar and contributor to Morningstar ETFInvestor. Big Banks Sequoia College Planning Summer 2008 Morningstar Advisor Morningstar Advisor magazine Free. Don’t miss an issue! Subscribe today! Call 888 235-0828 or visit MorningstarAdvisor.com MorningstarAdvisor.com 33

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Morningstar Advisor - June/July 2009

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