ETF Report




The MSCI USA SRI Index is based on the MSCI USA Index. The SRI index consists of the top ESG rated companies covering 25% of the float adjusted market capitalisation in each sector, which represents 150 stocks. While the parent index is well representative of the US market, the SRI index is more concentrated, especially on the stock level with the top holding weight of 13% (Microsoft). The index targets sector weights consistent with those of the parent to limit the systematic risk introduced by the ESG selection process. Such a best-in-class selection process is applied after the exclusion of companies involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, GMOs and adult entertainment. Also excluded are companies that don’t adhere to international norms and principles such as the UN Global Compact. As of this writing, most of the MSCI USA Index’ largest constituents are not included in the SRI index: such as Apple, Amazon, Facebook, J&J, and Alphabet. Microsoft is the only stock included in the SRI Index among the parent’s top 10 holdings. The MSCI USA SRI Index is reviewed on an annual basis in May to coincide with the semiannual review of the parent index as well as on a quarterly basis coinciding with the regular index reviews of the parent indexes. The constituent changes are implemented at the end of February, August and November. While removing the names that do not meet ESG eligibility criteria and new ones are added to those sectors with market cap coverage is less than 22.5%. In order to minimise turnover, 10% buffer is applied on the target coverage of 25%.

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The fund’s ongoing charge of 0.30% is lower than the category median. However, it appears relatively expensive compared with non-ESG US equity standard index trackers (including both S&P 500 and MSCI USA trackers) for which the average ongoing charge is below 0.15%.

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The fund employs full physical replication to track the performance of MSCI USA SRI Net Return Index. It intends to replicate the constituents of the benchmark index by holding all of the securities comprising the index in a similar proportion to their weightings in the index. The fund uses exchange traded equity index futures for efficient portfolio management: equitizing dividend accruals and managing daily cash flows. The fund does not engage in securities lending.

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This MSCI USA SRI ETF provides exposure to US companies that exhibit high ESG scores, with relatively low tracking error compared with its well-regarded parent MSCI USA index. Despite its smaller number of constituents, the index still displays similar characteristics to the parent. The fund’s stock concentration and relatively high fee relative to plain-vanilla US equity passive funds limit its Morningstar Analyst Rating to Silver.

The MSCI USA SRI Index is constructed by combining exclusions of companies involved in controversial activities and a best-in-class ESG selection approach. It consists of 150 names or around 25% of the MSCI USA index’ holdings. As the index employs float adjusted market-cap based weighting, its top holding, Microsoft, currently comprises around 13% of the whole portfolio. While the process leads to higher stock concentration, the ESG selection is conducted on a sector relative base. Thus, the sector allocation remains broadly in line with its parent MSCI USA Index. 

The fund has had a solid performance since inception in July 2016, with 2-year annualised total return ranking in the top decile of the Morningstar US equity Large-Cap category. While its live track record is limited, we expect the fund will continue to outperform category peers due to the similar risk-return profile to its highly regarded parent index. The MSCI USA Index is a well-diversified and broadly representative benchmark for the US equity market that has proved difficult for active fund managers to beat.  Despite notably reduced number of constituents (150 versus 620), the SRI index has followed its parent index relatively closely with a tracking error of 2.3% since the index inception in 2011. 

The fund’s ongoing charge of 0.30% lands in the higher-end of the fee range compared with standard US equity index trackers. For non-ESG US passive funds, the average fee falls below 0.15%.  

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Fundamental View

Sustainable investing is a long-term approach that incorporates environmental, social and governance (ESG) factors into the investment process. Given the increasing recognition that sustainability issues can affect a company’s bottom line, it is sensible to consider ESG aspects in a thorough investment process, especially one with a long-term perspective. This could also mean completely avoiding investing in companies whose business activities are broadly considered as unethical.

The MSCI SRI Indexes use proprietary business involvement research to identify companies involved in controversial activities. These include controversial and nuclear weapons, civilian firearms, tobacco, alcohol, adult entertainment, conventional weapons, gambling, nuclear power, and GMO.  Also excluded are companies that don’t adhere to international norms and principles such as the UN Global Compact and International Labor Organisation Core Conventions.  

Once this exclusion process defines broad universe, the SRI Indexes apply further scrutiny in its selection based on proprietary ESG ratings that identifies companies that have demonstrated an ability to manage their ESG risks and opportunities.

(Eccles et al 2012. The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance, El Ghoul et al 2011. Does corporate social responsibility affect the cost of capital?).

True to the above-mentioned studies, MSCI SRI Indexes tend to display slightly higher exposure to low volatility and quality factor compared with its market-cap weighted parent indexes demonstrated by higher ROIC, cash return, and financial health ratings.

Due to the market-cap based weighting on a smaller universe, MSCI SRI Indexes are prone to stock concentration. The top 10 constituents weighting at the MSCI USA SRI Index, for example, is around 38%, notably higher than that of 20% for the MSCI USA Index.

As of this writing, the fund has a High Morningstar Sustainability Rating of five globes. The rating is a measure of how well the companies held by a fund are managing their ESG risks and opportunities when compared with similar funds, including funds without explicit sustainability mandate.

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Recently launched Amundi MSCI USA SRI ETF is a direct alternative to this fund. Tracking the same benchmark index, the fund charges a lower fee of 0.18%.  

As for non-ESG alternatives, various ETF providers including iShares, UBS, Xtrackers, Lyxor, and Amundi offer products that aim to track the MSCI USA Index or S&P 500, with ongoing charges ranging from 0.07% to 0.30%. Xtrackers MSCI USA ETF and iShares Core S&P 500 are one of the cheapest options in the category.

Investors seeking just a simple ESG screen can turn to iShares MSCI USA ESG Screen ETF, which comes at the same ongoing charge of 0.07% as the cheapest plain-vanilla US equity index trackers. This ESG Screen Index fund excludes only 40 names out of the parent universe of 623, hence the lower tracking error of 0.5%. 

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