iShares Social ETF (DSI): The Good, The Bad and The Ugly

Published by Fernando on

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The iShares Social ETF is one of the oldest and most popular ESG ETFs from iShares. After an in-depth analysis to assess its social impact, we identify its strengths and weaknesses, and reach an interesting conclusion

Intro

We already know that funds with the word ‘Social’ on their names are not always positively impacting society. We have learned it the hard way when we analyzed Vanguard’s “Social” fund (Vanguard FTSE Social Index Fund or VFTAX). This time we will investigate iShares ETF options, which intend to have a social impact or, at least, are named and labeled this way.

The iShares Social ETF fully named iShares MSCI KLD 400 Social ETF (DSI) was established in November 2006, and with USD 2.2 billion of AUM, is the third-largest sustainable ETF from iShares (among those ETFs with exposure to the US market). The largest sustainable ETF from iShares is ESGU with USD 8.8 billion, followed by SUSL with USD 2.5 billion in AUM. We have reviewed those top 2 ESG ETFs before. In this blog post, we will analyze the iShares MSCI KLD 400 Social ETF or the ‘DSI’ ETF.

How impactful is iShares Social ETF?

The investment objective of iShares Social ETF (DSI)

According to iShares the investment objective of the iShares Social ETF (DSI) is “…to track the investment results of an index composed of U.S. companies that have positive environmental, social, and governance characteristics as identified by the index provider”.

The index mentioned by iShares is the MSCI KLD 400 Social Index. MSCI is a bit more optimistic when describing its index:

“a capitalization-weighted index of 400 US securities that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts”

What MSCI means is that to be eligible for the index, companies must have an MSCI ESG Rating above ‘BB’ and MSCI ESG Controversies Score greater than 2.

If we look at a comparable benchmark, for example, iShares Core S&P 500 ETF (IVV), constituents with MSCI ESG Rating above ‘BB’, represent 81% of IVV ETF. Thus, by approximation, only the bottom 19% of ESG rating companies are excluded from iShares Social ETF (DSI).

Analysis of iShares Social ETF (DSI)

MSCI indicates MSCI USA IMI as the index benchmark for the MSCI KLD 400 Social Index. When narrowing down MSCI USA IMI (2,336 holdings) to MSCI KLD 400 Social Index (around 400 holdings), without a strong ESG criteria, the index ends up having stronger concertation of large-caps and a high allocation at the top 10. While the top 10 constituents of MSCI USA IMI represent 14.9% of the index, the top 10 constituents of MSCI KLD 400 Social Index represent 31.5% of the index. This is directly reflected in the iShares MSCI Social ETF (DSI) allocation.

Another consequence of the higher allocation at the top 10 constituents, which are dominated by IT companies (Microsoft, Facebook, and Google), is the ‘DSI’ ETF higher exposure to the Information Technology sector, with 32.3% of its assets in that sector.

Portfolio comparison between iShares Social ETF and iShares Core S&P 500

iShares Social ETF (DSI) is not derived from the iShares Core S&P 500 ETF (IVV), however, there are strong correlations between both ETFs.

From the top 100 holdings in DSI, 97 are present in IVV. This is expected since most large companies have an MSCI ESG rating above ‘BB’. However, we noticed that DSI ETF leaves out some interesting companies listed in IVV. Looking at the constituents with more than 1.0% allocation in IVV, the ‘DSI’ ETF does not have exposure to Apple, Amazon, Berkshire Hathaway, Johnson & Johnson, UnitedHealth Group, and JP Morgan Chase.

We already learned that Berkshire Hathaway, Johnson & Johnson were excluded due to controversies (fossil fuels and animal testing). UnitedHealth Group and JP Morgan Chase have MSCI ESG ratings of ‘BB’, which is below the level required by the index. The giants Apple and Amazon, despite having MSCI ESG ratings of ‘A’ and ‘BBB’, have several controversies such as employee satisfaction and pay, workplace health and safety, and ethical practices.

On the good side, the performance of the iShares Social ETF (DSI) is strongly correlated to the traditional iShares Core S&P 500 ETF (IVV). By using the correlation tool from the Portfolio Visualizer, we can see that on monthly returns, DSI and IVV have a correlation of 0.98. This means that when investing in the iShares MSCI KLD 400 Social ETF investors can be slightly less exposed to ESG laggards and controversial industries, and still have returns similar to the S&P 500.

Analysis of holdings of iShares Social ETF (DSI)

According to MSCI ESG Ratings, DSI has a decent sustainability performance. It has a high ESG rating, good quality score and a moderate carbon intensity.

ETF NameiShares MSCI KLD 400 Social ETF
TickerDSI
MSCI ESG RatingAA
MSCI ESG Quality Score7.6
MSCI Carbon Intensity108.8
MSCI ESG % Coverage99.48%
*Carbon Intensity is measured in tCO2e per USD million sales

For a complete analysis, it is advisable to verify the sustainability performance of the ETF constituents or in this case their social responsibility. We know that due to the MSCI index criteria, the iShares MSCI KLD 400 Social ETF (DSI) is not expected to have companies with MSCI ESG Rating below ‘BBB’ or with MSCI ESG Controversies Score greater than 2.

However, let us look into the top 20 constituents of the iShares Social ETF (DSI):

  1. Microsoft
  2. Facebook
  3. Alphabet (class C)
  4. Alphabet (lass A)
  5. Procter & Gamble
  6. Visa
  7. Nvidia Corp
  8. Tesla
  9. Mastercard
  10. Home Depot
  1. Verizon Communications
  2. Adobe
  3. Salesforce.com
  4. Walt Disney
  5. Intel Corporation
  6. Paypal Holdings
  7. Merck & Co
  8. Coca-Cola
  9. Pepsico
  10. McDonald’s

When it comes to social impact, there are a few red flags on this list. We have previously briefly presented the impact that Facebook can have on politics and mass manipulation. And we could potentially find social issues, directly or indirectly, caused by some of the other companies on this list. However, three companies caught our attention. At the bottom of this list, we have Coca-Cola, PepsiCo, and McDonald’s.

Coca-Cola and PepsiCo are the largest producers of sugar-sweetened beverages or “soft” drinks with a combined 72% of the US market share. And McDonald’s is the largest fast-food producer with 21.4% of the global market revenue.

Numerous studies show the correlation between the consumption of soft drinks and diabetes, and the consumption of fast food and obesity. When the main products of companies are a direct cause of health and social issues, it is not appropriate and highly misleading to add those companies into an ETF that has ‘Social’ on its title.

Does ESG catch those social and health issues on its methodology? Let take a further look.

The limitations of the ESG methodology

As we concluded above, the iShares Social ETF (or MSCI KLD 400) should not be called ‘Social’ and that is mainly due to limitations from the ESG methodology. Large companies like Coca Cola, PepsiCo, and McDonald’s could, in theory, work hard enough to get an almost perfect score on their ESG ratings. They could focus on:

  • Improving production efficiency and use of resources (Environment)
  • Improving the conditions of its workforce and employees’ rights (Social)
  • Improving corporate governance and behavior (Governance)

Their ESG rating would be almost perfect because they would be missing one critical item under the Social aspect of ESG: product liability. As presented by MSCI, product liability is related to product safety and quality, chemical safety, financial product safety, privacy, and data security, responsible investment and health, and demographic risk.

One can argue that soft drinks and fast food should score very low when it comes to product safety and consumers’ health. Coca Cola is aware of that risk and ranks it as high concern from its stakeholders and with a potential of high impact on its business.

However, this would not be enough to impact the overall ESG rating of those companies. Product liability is only one among dozens of ESG criteria in a company checklist. The real ESG risk is on the likelihood of sugary drinks and fast food becoming a controversial business, like how the tobacco industry is perceived now.

Despite alerts from the medical community regarding the consumption of soft drinks and fast food, and discussions to implement a “sugar tax”, the likelihood of labeling soft drinks or fast food as a controversial business seems to be remote.

SDG ETF: A small ETF with much better social impact

As we have seen above, the iShares Social ETF (DSI) have weak ESG criteria, and consequently, it is not causing enough social impact. Moreover, even strong ESG criteria would have limitations when it comes to what the company is producing. It is not the focus of the ESG methodology and metrics to thoroughly investigate the impact that products and services have on society.

The ESG methodology does cover the impact of products or services on the environment, but the social consequences of acquiring and utilizing those products and services are not fully addressed by ESG. This exact ESG limitation is what differentiates it from impact investing.

Impact investing as defined by the Global Impact Investing Network: “Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”

If you, as an investor, is looking to create positive social impact, it is much more effective to look for ETFs that have an impact focus and are created based on the core intention and purpose of businesses, rather than weak ESG metrics.

Luckily, iShares have one option among its sustainable ETF family. The iShares MSCI Global Impact ETF (ticker: SDG) has the investment objective to:

“track the investment results of an index composed of positive impact companies that derive a majority of their revenue from products and services that address at least one of the world’s major social and environmental challenges as identified by the United Nations Sustainable Development Goals”.

Therefore, only companies that have 50% or more of their revenues coming from activities that support one of the United Nations 17 Sustainable Development Goals are eligible to be a constituent of the iShares MSCI Global Impact ETF.

Here are the top 20 constituents of the iShares Global Impact ETF:

  1. Vestas Wind Systems
  2. Tesla
  3. Procter & Gamble
  4. Johnson Matthey
  5. East Japan Railway
  6. Umicore
  7. Central Japan Railway
  8. Gilead Sciences
  9. Suez
  10. Amgen
  1. Kimberly Clark
  2. Nio American Depositary Shares
  3. Wh Group
  4. Empresas CMPC
  5. Berkeley Group Holdings
  6. Novo Nordisk (class b)
  7. Alstom
  8. Byd Ltd
  9. Pearson
  10. Samsung

The downside: iShares MSCI Global Impact ETF has a broader exposure than iShares Social ETF. The ‘SDG’ ETF does not focus only on social impact, but sustainable impact. Moreover, it is not limited to US companies, it is exposed to global stocks.

DSI vs. SGD: How does iShares Social ETF compare to the Global Impact ETF?

A quick glance at the MSCI sustainability characteristics of ‘SDG’ and ‘DSI’ ETFs do not indicate a big difference between those ETFs:

ETF NameiShares MSCI KLD 400 Social ETFiShares MSCI Global Impact ETF
TickerDSISDG
MSCI ESG RatingAAAA
MSCI ESG Quality Score7.67.2
MSCI Carbon Intensity108.8149.1
MSCI ESG % Coverage99.48%99.91%
*Carbon Intensity is measured in tCO2e per USD million sales

However, iShares has a complimentary report for impactful ETFs, the Impact Report. There we can see that regarding sustainable impact (which includes social impact), The ‘DSI’ ETF has only a 4.09% greater exposure to sustainable solutions when compared to its benchmark (MSCI USA IMI Index) and is only aligned to 5 of the UN Sustainable Development Goals. On the other hand, the ‘SDG’ ETF has a 67.7% higher exposure to sustainable solutions when compared to its benchmark (MSCI ACWI Index) and is aligned with 10 out of 17 of the UN Sustainable Development Goals.

Another source that corroborates the sustainable advantage of iShares MSCI Global Impact ETF is the Fossil Free Funds (in fact a great tool to access the sustainability of US-based ETFs – and it covers more than carbon footprint).

Sustainability Report CardiShares MSCI KLD 400 Social ETFiShares MSCI Global Impact ETF
TickerDSISDG
Fossil fuel gradeB - ishares social etfB - ishares social etf
DeforestationF - ishares social etfF - ishares social etf
Gender equalityA - ishares social etfD - ishares social etf
Civilian firearmsA - ishares social etfA - ishares social etf
Prison industry complexD - ishares social etfA - ishares social etf
Military weaponsF - ishares social etfA - ishares social etf
TobaccoB - ishares social etfA - ishares social etf

According to Fossil Free Funds, the iShares MSCI Global Impact ETF performs better than iShares MSCI KLD 400 Social ETF. The former has four As and one B, while the latter has only 2 As and 2 Bs.

Both perform badly in ‘Deforestation’. The main driver of that is the ETFs’ allocation to Procter & Gamble Co, which has issues with palm oil harvesting practices in Indonesia.

The iShares MSCI Global Impact ETF is not perfectly sustainable, since it has also another low score, a ‘D’ for ‘Gender equality’. According to Fossil Free Funds, the main drivers are the ETF exposure to Tesla, NH Foods, and CSPC Pharmaceutical Group Ltd.

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Conclusion

Once again, a social ETF fails the Your Green Wealth test. The iShares MSCI KLD 400 Social ETF does not deserve the word ‘Social’ on its title. Its ESG criteria are weak and insufficient to screen out companies with average MSCI ESG ratings or poor product liability.

Moreover, ESG might not be the right methodology to create a truly impactful ETF. To be effective, the ESG methodology needs to be combined with the UN Sustainable Goals, enabling the selection of companies that have social and environmental issues at the core of their business’s purpose and strategies.

When looking for a social impact ETF from iShares, the iShares MSCI Global Impact ETF is a better option. It is not perfect, but has a better sustainable performance and has at least an honest social impact mission:

“composed of positive impact companies that derive a majority of their revenue from products and services that address at least one of the world’s major social and environmental challenges as identified by the United Nations Sustainable Development Goals”.


Not an investment advice: The information provided on this website is intended for general information purposes only and does not constitute investment advice, financial advice, trading advice, or any other sort of advice. You should conduct your due diligence and, if necessary, consult a qualified independent financial advisor before making any investment decisions.

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Fernando

Fernando created Your Green Wealth to help investors find sustainable investing options. When not writing for Your Green Wealth, he is a business developer for renewable energy projects.

4 Comments

Nic · November 2020 at 18:30

Hi, I read your article and I found it really interesting. I agree with you to say that most ESG indexes are really about removing the worst of the worst than selecting only the best few. I’d like to add that the ESG metrics used by MSCI and other rating agencies only highlight what’s on the surface and do not deep dive into the real issues. Another thing I wanted to add and maybe more important, if you strip all the top performers of an index (say S&P 500), because as you said in your article, the most valuable companies today do not have the highest ESG rating, can you still guarantee market average performance for your portfolio?

    Fernando · November 2020 at 18:51

    Hi Nic,
    Thank you for your comment. I agree that most rating agencies are not looking deep enough into sustainability issues, but also think that they are working to improve their ESG criteria and will be able to dig deeper in the future.
    ESG criteria would not necessarily remove all the top performers of S&P 500. Also if we look at the last 10 years, the most valuable companies were not all listed as top performers of S&P500. But I do, understand your point and the answer is that looking backward, it would be challenging to guarantee market performance in a strict ESG portfolio. However, in the past, companies have not been fully accounted for their externalities (e.g. carbon taxes) or social impact (e.g. workers’ rights and wages).
    I do think that in the coming 10 years and beyond, those factors will be considered as investment risk, and companies that do not follow basic ESG criteria will be penalized in the stock market. The questions that remain are: to what level and how soon that will happen?

      Nic · November 2020 at 16:18

      I completely agree with you and I didn’t know that FAANGs were not the best performing stocks in the past 10 years (besides NFLX). I am convinced like you are that ESG is a risk not enough looked at enough when valuing companies. And I cannot answer your question (not sure who can) but how do you think we (as individuals) can promote ESG and push people to divest from companies with low ESG ratings? And is investing in a low ESG rating company necessarily a good thing?

        Fernando · November 2020 at 22:43

        I think that the argument in favor of sustainable investing can be quite appalling for pensioners. A lot of people are saving for their retirements 20-30 years from now, but they are also concern about what future they will leave for their kids. Pension funds are starting to realize that and starting to offer green investment alternatives.
        Another way is to look into performance (at least in some sectors). Clean energy is in a clear upwards trend, being 2020 a good example of how clean energy easily overperformed fossil fuel stocks. Thus, both arguments, personal values and performance, could be used to convince investors.

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