investingPeople are increasingly making their personal philosophy a pocketbook issue, aligning their their portfolio with their beliefs. Now, socially responsible investing (SRI) has come to ETFs, though it's only a tiny part of the nearly $3 trillion in the SRI area. Currently, there's $3.2 billion invested in 24 SRI ETFs, according to Morningstar.

That number is expected to grow as interest in SRI ETFs continues to gain traction. For example, last month Pax World announced three new ETFs called ESG Shares. ESG Shares North America Sustainability Index ETF (NASI) has launched. Next up are the ESG Shares FTSE Environmental Technologies (ETFY), and the ESG Shares Europe Asia Pacific Sustainability Index ETF (EAPS).

This is the first family of ETFs devoted exclusively to a sustainable investing approach -- a full integration of environmental, social and governance (ESG) factors in financial analysis and investment decision making. The funds track indexes that integrate ESG factors into their index design and construction. For example, ESG Shares North America Sustainability Index ETF seeks to track the performance of the FTSE KLD North America Sustainability Index, a broadly diversified, sector-neutral index of American and Canadian companies touted as having superior ESG performance as rated by KLD Research & Analytics.

Buyer Beware

Sounds good enough. However, labels can be deceiving. An exchange-traded fund billed as being socially responsible sounds like something that would align with values akin to good corporate citizens -- companies that treat their employees well, are governance champions, shun "sin" products like alcohol, tobacco, defense, or are pleasantly green and getting greener. But buyer beware. What looks like a duck and walks like a duck still may be something else. Such is the case with some socially responsible ETFs.

There are misconceptions about SRI. Every company that you find in a SRI portfolio isn't necessarily a fanatical do-gooder. Many of them are well known companies that are in many funds -- think names like Johnson & Johnson (JNJ), General Electric (GE) and Apple (AAPL).

Then, too, there are some challenges just given the anatomy of an ETF. They're passive by nature, so the process for determining eligible companies must be standardized and prohibit manager distraction, as Michael Johnston pointed out in his recent report for ETFdb.com.

For example, FTSE KLD Select Social Index Fund (KLD) is linked to an index that consists of large-cap companies that are determined to have positive environmental, social and governance performance relative to their industry and sector peers and in relation to the broader market, while at the same time maintaining risk and return characteristics similar to the FTSE U.S. 500 Index. According to the fund's prospectus, the index provider "evaluates each eligible company's ESG performance using standardized criteria and assigns overall rating to each company."

Transocean and Haliburton in a Socially Responsible Fund?

Again, sounds good, but ETF's much touted transparency reveals some interesting holdings. As of June 10, KLD has more than $200,000 in Transocean (RIG). The company has the distinction of being the owner of the drilling rig in the historic Gulf of Mexico oil leak that has captured the world's attention for nearly two months. "You have to ask yourself why Transocean would be in this portfolio because it's an obvious infraction of clean technology," says Jim Porter, portfolio manager of the Aston/New Century Absolute Return ETF Fund.

KLD also has more than $150,000 in Haliburton (HAL), which was also involved in the Gulf disaster and has had reputation scrapes in the past. More than $680,000 is in the financial sector whipping boy of the moment, Goldman Sachs (GS).

So how do such securities get in the mix? "Marketing plays an important part in the SRI universe. SRI investing is an attractive concept. However, how the fund is screened is determined by managers that make the call about what gets included in the portfolio. The manager is competing with and being compared to many others in the same space. As a result, the securities in any fund may not match an investor's expectations," explains Rose Greene, a certified financial planner and founder of Rose Greene Financial Services.

Differing Interpretations of SRI

Also, there's no universal standard of SRI says George Gay, CEO of First Affirmative Financial Network, an independent registered investment advisor that specializes in socially conscious investors. "Each client has some personal views that go into their idea of 'social responsibility'. Certainly different social research firms may have the same general standards, but they may weight them differently, they may have different 'hurdle points' or acceptable rates of exposure, or even different definitions of what a certain screen might mean. Just as with 'organic foods' there are a range of ways for the label to be applied," he adds.

Investors should keep in mind that there's a distinction between a "green" ETF and a Socially Responsible ETF. "Green ETFs are focused on targeted industries, like wind, solar or green tech, but generally don't do social research on the environmental, labor or other aspects of the individual companies in the ETF. Socially responsible ETFs are based on indexes where the components of the index have passed through social research and screening process," says Gay.

So what does all this mean? If you're going for a SRI ETF, be sure you're getting what you think you are. To find the composition of a particular SRI ETF, plug in the ticker into Morningstar and then view the portfolio components. Morningstar typically displays the Top 25 holdings on the basis of the proportion of net assets. You can also go on the providers' website and pull up the complete list of holdings.

"Investors should research and fully understand not only the ETF they're considering for investment, but also the underlying index that the product is tracking," points out Kevin Mahn, portfolio manager of SmartGrowth Funds.

Should You Divest?

A big question, though, is what to do if you find out your ETF doesn't jive with your philosophies. "If an ETF holds only one or two questionable positions, evaluate what percentage of the total portfolio those holdings represent. If an objectionable company represents a 1% position in an ETF that is 10% of an investment portfolio, that exposure is one-tenth of 1%. It probably doesn't make sense to divest for that reason, unless it causes a serious doubt of judgment or investment practices of the entire management firm," says Gay.

However, says Porter, "If it's no longer aligned with your values, especially because you sometimes pay more for a socially responsible investment, and if you aren't getting great returns, as some SRI ETFs have underperformed the S&P 500, then walk away."

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