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I currently invest in index funds (VFINX and FUSEX) but would like to negatively screen out certain categories of investments for the purposes of "Socially responsible investing". I don't have any need to positively select socially responsible industries like environmental, equality, labor businesses, but I sure would like to avoid funding defense contractors.

Are there investment instruments which have the beneficial attributes of index funds like low fees, but exclude certain categories of businesses?

I'm not looking to exclude all "sin stocks" (e.g. alcohol, animal testing, gambling) so the blanket SRI investment instruments like VFTSX aren't really what I'm looking for

  • Does money.stackexchange.com/questions/52313/ethics-and-investment not address your question? – JTP - Apologise to Monica Mar 31 '16 at 22:05
  • @JoeTaxpayer , that question has some good information (suggesting some SRI investment options and some opinions that SRI is bogus) but I didn't see anything about the intersection of index funds and SRI. Since that link looks to have been replied to be a good number of people, and nothing is mentioned about index funds and SRI, I suspect I may be out of luck (and there is no good solution). Thanks for pointing me to that question, in my stackexchange searches I'd not found it. – gene_wood Apr 1 '16 at 1:59
  • The only reason I found it is that my answer suggested Domini. I searched on that name. – JTP - Apologise to Monica Apr 1 '16 at 2:15
  • So defense contractors are the only class of company that you want to exclude? – Ben Miller - Reinstate Monica Apr 1 '16 at 3:57
  • "Socially responsible" could be subjective. One might consider defense contractors to be acceptable, others as not acceptable. It also depends on the country, which you did not specify. (some countries are conducting military operations outside of their borders, others don't) – vsz Apr 1 '16 at 10:11
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It would involve manual effort, but there is just a handful of exclusions, buy the fund you want, plug into a tool like Morningstar Instant X Ray, find out your $10k position includes $567.89 of defense contractor Lockheed Martin, and sell short $567.89 of Lockheed Martin. Check you're in sync periodically (the fund or index balance may change); when you sell the fund close your shorts too.

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    A bit baroque, but yeah, it sorta works.. – keshlam Apr 1 '16 at 0:29
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    Can one do this inside of an American tax-deferred investment, such as an IRA or 401(k)? – Jasper Apr 1 '16 at 3:46
  • Alternatively, less precisely but in a similar spirit, there are a few index funds devoted to defense companies. You could short such a fund. – Nate Eldredge Apr 1 '16 at 4:19
  • @Jasper i believe IRAs cannot borrow, so they cannot short a position. But there's a hysteresis to exploit (assuming defense contractors, like the US economy at large on the long term, will tend to have a positive return) in having the expected gain in tax deferred; and expected losing short in taxable to harvest. – user662852 Apr 1 '16 at 20:35
  • Clever, but really defeats the purpose of an index fund (reduce risk). – ChuckCottrill Apr 2 '16 at 17:48
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I think the answer to your question is no, in theory. By screening out funds, you must actively manage the investments. To then try to ensure you track the index closely enough, you have to do further management. Either you spend your own time to do this or you pay someone else.

This is ok, but it seems contrary to the primary reasons most people choose an index fund and why the product exists.

You want a specific type of ethical investment(s) that has lower fees and performs well. I think you can get close, it just won't be like an "index fund". Don't expect equal results.

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    Exactly. If you're screening out (or in) stocks by any other criteria than their presence in the index the fund is tracking, it stops being an index fund, pretty much by definition. So you would have to look for a fund that shares your ideas of exactly what constitutes "ethical investment". – jamesqf Apr 1 '16 at 4:07
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You could certainly look at the holdings of index funds and choose index funds that meet your qualifications. Funds allow you to see their holdings, and in most cases you can tell from the description whether certain companies would qualify for their fund or not based on that description - particularly if you have a small set of companies that would be problems.

You could also pick a fund category that is industry-specific. I invest in part in a Healthcare-focused fund, for example. Pick a few industries that are relatively diverse from each other in terms of topics, but are still specific in terms of industry - a healthcare fund, a commodities fund, an REIT fund. Then you could be confident that they weren't investing in defense contractors or big banks or whatever you object to.

However, if you don't feel like you know enough to filter on your own, and want the diversity from non-industry-specific funds, your best option is likely a 'socially screened' fund like VFTSX is likely your best option; given there are many similar funds in that area, you might simply pick the one that is most similar to you in philosophy.

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It sounds like you need an index fund that follows so called Sustainability index.

A sustainability index does not simply select "socially responsible" industries. It attempts to replicate the target market, in terms of countries, industries, and company sizes, but it also aims to select most "sustainable" companies from each category.

This document explains how Dow Jones Sustainability World index is constructed (emphasis mine):

  • The world’s largest 2,500 publicly traded companies are invited to participate in RobecoSAM’s CSA for possible inclusion in the Dow Jones Sustainability World Index (DJSI World)
  • 59 RobecoSAM industries derived from the GICS industry classification system are analyzed using industry-specific questionnaires
  • No industries are excluded from the assessment
  • Companies are evaluated based on a range of financially relevant sustainability criteria covering the economic, environmental and social dimensions
  • Companies receive a Total Sustainability Score between 0 – 100 and are ranked against other companies in their industry
  • The top 10% of companies within each industry are selected for inclusion in the DJSI World

An example of a fund following such index is iShares Dow Jones Global Sustainability Screened UCITS ETF, which also excludes "sin stocks".

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Hmm, this would seem to be impossible by definition.

The definition of an "index fund" is that it includes exactly the stocks that make up the index. Once you say "... except for ..." then what you want is not an index fund but something else. It's like asking, "Can I be a vegetarian but still eat beef?" Umm, no.

There might be someone offering a mutual fund that has the particular combination of stocks that you want, resembling the stocks making up the index except with these exclusions. That wouldn't be an index fund at that point, but, etc. There are lots of funds out there with various ideological criteria. I don't know of one that matches your criteria. I'd say, search for the closest approximation you can find.

You could always buy individual stocks yourself and create your own pseudo-index fund. Depending on how many stock are in the index you are trying to match and how much money you have to invest, it may not be possible to exactly match it mathematically, if you would have to buy fractions of shares. If the number of shares you had to buy was very small you might get killed on broker fees.

And I'll upvote @user662852's answer for being a pretty close approximation to what you want.

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