New LGBTQ ETF for Investors to Evaluate
On May 18, 2021, investors gained access to a new ETF with a focus on investing in LGBTQ-friendly companies. The new ETF is called the “LGBTQ + ESG 100 ETF,” and it trades under the symbol “LGBT” (NASDAQ:LGBT).
The new ETF is the result of an effort led by a new organization called LGBTQ Loyalty Holdings, Inc. (“LGBTQ Loyalty”), in collaboration with ProcureAM (the investment manager of the fund) and Fuzzy Logix (an analytics company that manages the index that the fund is tracking).
As with all ETFs, a methodology is used to determine the holdings of the ETF. For this fund, a new index called the LGBTQ100 Index was created for the fund to track.
The goal of the new index is to create a portfolio of holdings that represent “the top 100 U.S. companies that nurture and promote equality in the workplace for employees of all gender and sexual orientation; have a history of consistently strong financial performance; and either (1) have a strong track record of loyalty and brand awareness among the US-based LGBTQ community or (2) observe high standards on environmental, social and governance (‘ESG’) issues.” [1]
For LGBTQ investors, this ETF in theory provides an easy way to focus their investments on LGBTQ-friendly companies. But in practice, this ETF may not be a good fit for all investors.
First, some history: this is not the first LGBTQ ETF to be introduced in the marketplace. Two previous LGBTQ ETFs launched in the 2010s, but they failed to gain traction in the marketplace and eventually dissolved, returning their net asset value to investors.
This new fund seeks to address the perceived shortcomings of the previous funds. The fund sponsor, LGBTQ Loyalty, has a board that includes a few well-known LGBTQ celebrities such as Barney Frank, Martina Navratilova and Billy Beane. The presence of these LGBTQ leaders may provide comfort to investors that important LGBTQ activists are involved in this venture, although it should be noted that none of these people has a strong background in investments or ESG investment strategy. In addition, the index that the fund seeks to track has a couple of innovative screening features.
Complex Methodology
In order to understand this ETF, it is important to review the methodology for how the LGBTQ100 index is created.
The index starts with a potential investable universe of the Fortune 1000, which are the top 1,000 US-based companies by revenue. From this universe, the following screens are applied to reduce the number of companies that can be included in the index. To make it through the screen, a company must:
Earn a 100% rating in an annual self-reported survey on LGBTQ policies conducted by a national LGBTQ organization
Be among the top 500 publicly-listed US corporations by market capitalization
Not be a “sin stock” (i.e., no business in guns, tobacco, or pornography); not have most of its operations involved in gambling; and not have any business selling weapons of mass destruction
Have substantial liquidity in the trading of its stock
Have a free float of at least $7.5 billion
In addition, a company must not be in the bottom quartile for either: (i) an ESG score, as provided by Institutional Shareholder Services OR (ii) LGBTQ Brand Loyalty & Support, based on the results of a Harris Poll that surveys attitudes among LGBTQ people for individual companies’ brand image, brand loyalty and LGBTQ support.
For this year, the initial screening process reduced the investable universe from the initial 1,000 companies to 170 companies.
These remaining companies are then ranked based on previous year-over-year sales growth. The top 100 companies by sales growth become the constituents of the index, although at least two companies from each major industry group are always included.
The portfolio is weighted based on a composite score that rewards three metrics: (a) minimal stock-price volatility; (b) free-float market capitalization and (c) a high price-to-earnings ratio. No individual company can receive a weighting greater than 5% and no industry can be greater than 25% of the overall portfolio. The weighting is reset every quarter.
Analysis
This is one of the more complicated ETFs in the marketplace. But there are several things that investors should be aware of before investing in this fund:
(1) The Harris Poll is the “special sauce” of this ETF, but is perhaps underutilized in creating the index. This is the first LGBTQ ETF which relies in part on original research to create the index by polling the LGBTQ community’s attitudes of companies. But the index also allows companies to be part of the index even if they don’t perform well in the LGBTQ survey as long as they have at least an average overall ESG rating. This methodology choice was probably made because there are many industrial companies which most of the general public has never heard of and therefore would have no opinion of when taking the Harris Poll. Providing an alternative of qualifying for the index via an overall ESG score allows many large but lesser known companies to be part of the index and enables the index to have greater industry diversification. But this methodology choice does reduce the LGBTQ-focus of the portfolio. In addition, by allowing the top three quartiles of companies to be in the index, the function of the ESG and LGBTQ-support screens is mostly to exclude the companies with the worst ESG/LGBTQ policies and brand image, rather than focusing the portfolio on the truly best companies.
(2) The index’s initial screening results in a curious portfolio. First, by starting off with investable universe of the top 1000 companies by revenue, the index likely excludes many high-margin, high-growth, mid-sized companies that are highly valued in favor of large but lower-margin companies in industries such as retail and commodity consumer products. But conversely, in the final screen the index ranks companies by year-over-year sales growth. These methodology choices lead to a bias of overweighting faster-growing companies, but only the ones that have the most revenue to begin with.
As a result, this fund, relative to broad large-cap indices, ends up having an overweight allocation to consumer cyclicals and is significantly underweight to technology companies. [2]
(3) The overall ESG ratings of the fund are good, but not best-in-class. MSCI, a provider of portfolio analytics, rates the ETF with an ESG rating of “A” (3rd best rating out of 7) and Morningstar, another provider of financial data, places this LGBT ETF in the 79th percentile for sustainability. Such ratings are not a surprise given that the index’s strategy is to only exclude the worst companies for ESG performance rather than focusing the portfolio on the best-in-class companies. However, to the extent that an investor wants to focus their investments on best-in-class ESG performers, this fund may not be the best vehicle through which to do so. [3]
(4) The fund has an expense ratio of 0.75%. The expense ratio of the fund is in-line with other ESG-focused ETFs. However, an investor needs to decide whether money spent on fund expenses would be better deployed by investing money in a low-cost index fund and using the saved money to support charitable causes.
(5) The index and the ETF are new and liquidity may be limited. The fund only has $4 million of assets under management, which makes it a very tiny ETF, and the average daily trading volume is only $68,000. This may create issues for investors that need to quickly sell significant holdings of the ETF in the future. [4]
Conclusion
The managers of LGBT have created an interesting methodology for creating an LGBTQ-centric ETF. But in creating this ETF, the managers have made certain tradeoffs for the sake of creating a well-diversified portfolio. The choice to focus exclusively on very large companies and to have 100 companies in the index yields a portfolio that excludes “bad actors” from the portfolio, but does not necessarily create a portfolio composed of “best-in-class companies” when it comes to LGBTQ inclusion. In addition, the portfolio creates some portfolio weighting issues that would need to be managed within a broader portfolio.
Quiet Wealth’s conclusion is LGBT could be a small piece of some investors’ equity portfolios, but should not be a core holding. Determining how big of an allocation an investor should make to LGBT depends on several factors, including the investor’s overall financial goals and an investor’s specific goals for ESG investing.
Notes:
[1] LGBT prospectus https://paletfs.com/wp-content/uploads/2021/06/Procure-LGBTQ-ESG100-ETF-Prospectus-public.pdf
[2] Based on analysis published on ETF.com as provided by MSCI. Data as of September 11, 2021.
[3] Based on Morningstar and MSCI data as of September 11, 2021.
[4] Data as of September 11, 2011.
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