CVLC ETF: Research-Driven ESG Investing (NYSEARCA:CVLC)

The Calvert US Large-Cap Core Responsible Index ETF (NYSEARCA:CVLC) offers diversified exposure to companies seen as leading through environmental, social, and governance standards.

Compared to alternative (ESG) funds, the attraction of Calvert is the group’s recognized specialty in socially responsible investing that includes a research-driven approach to index construction. Favorably, the fund has delivered a solid performance over the past year and has even outperformed benchmarks thus far in 2024.

Overall, we find CVLC as a suitable option within the universe of ESG exchange-traded funds, or ETFs, well-positioned to continue delivering positive returns. Could it be a good addition to your portfolio? Here’s what you need to know.

What is the CVLC Fund?

Calvert Research and Management is a group within the asset management division of Morgan Stanley (MS), acquired back in 2020.

The CVLC ETF is intended to track the “Calvert US Large-Cap Core Responsible Index,” which is constructed by a separate team within the same organization.

According to the index methodology, Calvert utilizes a five-step process to identify companies that effectively manage their ESG risks and opportunities, while also avoiding companies that have excessive ESG risks. From identifying the peer group and developing a thesis, companies are ranked across the structural model based on ESG risks and opportunities.

The idea here is that well-run companies that have strong governance, manage their environmental impact, and score positively in social factors such as treating employees and customers well should be able to deliver positive shareholder returns over the long run.

Starting with the largest 1,000 U.S. stocks, Calvert’s research process identifies between 700-800 index components. These constituents are included through market-cap weighting. The index and ETF are reconstituted annually, with a quarterly rebalancing.

Going through the current portfolio, there are not many surprises with mega-cap leaders like Microsoft Corp (MSFT), Apple Inc. (AAPL), Nvidia Corp. (NVDA), and Alphabet Inc. (GOOGL) as the top holdings. Of the largest 1,000 U.S. stocks, approximately 80% are included.

What’s more telling are the companies Calvert has chosen to exclude. For example, CVLC does not include Berkshire Hathaway (BRK.B), citing the financial conglomerate’s lack of initiative toward energy transition. Similarly, CVLC does not invest in Meta Platforms, Inc. (META) based on the company’s “large-scale data privacy and security concerns”.

Tobacco stocks are excluded, while the 0.46% exposure to energy sector stocks is well below the 3.8% weighting found in the Russell 1000 or S&P 500 Index (SP500).

Performance of CISIX Mutual Fund

While the CVLC ETF began trading with a fund inception date in January 2023, the actual index has been tracked by the corresponding Calvert US Large-Cap Core Responsible Index (CISIX) mutual fund since 2000.

We mention this because it provides a sense of the strategy’s long-term performance, even if the new CVLC ETF structure through a different management team is not directly comparable.

Over the past decade, CISIX has delivered a 233% cumulative total return, which is above the 229% gain in S&P 500 tracking mutual funds like the Vanguard 500 Index Admiral Fund (VFIAX).

At the same time, if we go back even further since the CISIX mutual fund to its inception, its full historical performance underwhelms, lagging the S&P 500, particularly in the first half of the last decade.

The point here is not to suggest Calvert’s ESG-focused strategy is a dud or can’t deliver long-term excess returns going forward, but simply that there are limitations to the investment thesis. The underweight exposure to the energy sector and materials means CVLC and CISIX would naturally face an upside tracking error to benchmarks that are more diversified in this regard.

On the other hand, the performance factors that make ESG stand out, such as a focus on the clean energy transition, may become more evident over the next ten or twenty years.

Is the CVLC ETF a Good ETF?

One of the challenges of ESG investing is the sometimes subjective nature of ratings and diverging opinions on what types of corporate activities are socially responsible or not.

Even within CVLC, the decision to exclude shares of Berkshire Hathaway is just one example of a direction ESG can cause controversies that many investors would not agree with.

From an investing standpoint, our take is that efforts to limit diversification by systematically avoiding certain sectors or industries keep the strategy disadvantaged compared to modern portfolio theory.

Simply put, a scenario where oil & gas or natural resource mining stocks lead higher would likely mean CVLC would underperform broad market benchmarks. Recognizing that clean energy and renewable technologies are the future, it’s still unclear whether ESG strategies will outperform over the long run.

Still, it’s also understood that the governance factor within ESG is a critical component of what can make companies good investment candidates or not. By this measure, we can look at CVLC as performing a sort of fundamental screen that at least identifies companies that have more serious governance deficiencies beyond any environmental or social angle.

Overall, ESG investing may not be for everyone but serves an important role in the market. We’ll need more time to assess the performance of CVLC through the next full market cycle.

Final Thoughts

For investors who understand the limitations of ESG risk factors and are seeking socially conscious exposure, Calvert US Large-Cap Core Responsible Index ETF is a high-quality fund and worthy of consideration. The fund’s 0.15% expense ratio is reasonable in our view, while the fund also delivers a modest 1% dividend yield distributed quarterly.