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Investment Thesis
The Global X S&P 500 Catholic Values ETF (NASDAQ:CATH) provides exposure to 433 S&P 500 Index companies meeting the Socially Responsible Investment (“SRI”) Guidelines for the United States Conference of Catholic Bishops (“USSCB”). For faith-based investors, it sounds promising, but my takeaway is that the USSCB places more emphasis on profits than the exclusion criteria they advertise, and as such, I don’t recommend buying. I look forward to explaining why in further detail below.
CATH Overview
Strategy Discussion
CATH tracks the S&P 500 Catholic Values Index, selecting S&P 500 companies that adhere to the Socially Responsible Guidelines for the United States Conference of Catholic Bishops. Below are three reasons investors should consider CATH, according to Global X.
First, the Index uses an exclusions method to eliminate companies the USSCB perceives as inconsistent with Catholic values. The exclusions are revenue-based, and activities not permitted include abortion, controversial weapons, contraceptives, and human embryonic stem cells. The Index has slightly looser restrictions for adult entertainment, tobacco, cannabis production and retail, gambling, and military contracting. Finally, the Index looks for “evidence of significant incidents” related to child labor.
Global X
The Index also seeks to minimize tracking error with the S&P 500 Index with a “sector-neutral” approach. This means CATH’s sector exposures are nearly identical to SPY’s at each rebalancing, and the primary sources of tracking error are the ETF’s higher expense ratio and the returns of the stocks it excludes. It’s standard practice for some of the most popular ESG ETFs, as most financial analysts who study performance attribution know the asset allocation effect is usually stronger than the stock selection effect. You’re bound to get similar returns by eliminating the former, provided the selection changes you make aren’t drastic.
As for CATH, it doesn’t change things up much. It only excludes three stocks whose weights are above 1% in the S&P 500 Index: Amazon (AMZN), Eli Lilly (LLY), and UnitedHealth Group (UNH). Furthermore, no stock is overweighted by more than 1%, so the Index takes minimal active risk, and you can quickly determine why CATH’s returns differ from SPY’s by looking at the performance of these three stocks. I’ll highlight the exclusions in more detail shortly, but first, I want to take some time to help you better understand the SRI Guidelines that drive CATH.
Socially Responsible Investment Guidelines: USSCB
The following is an excerpt from the SRI Guidelines put forth by the USSCB in November 2021:
It is true that most shareholders today exercise relatively little power in corporate governance. Although shareholders can and should vote on the selection of corporate directors and on investment questions and other policy matters, it appears that return on investment is the governing criterion in the relation between them and management. We do not believe that this is an adequate rationale for shareholder decisions.”
With this statement, the USSCB sets the stage for a policy that is most interested in elevating the Church’s social values above all else, which is exactly what I would expect. However, that’s quickly challenged by its two guiding principles, which I’ve paraphrased below:
1. The Conference should obtain a reasonable rate of return on investments that matches the level of the market or at least allows the Conference to meet its fiduciary responsibilities.
2. The Conference should exercise ethical and social stewardship by investing based on Catholic moral principles. Its strategy should be based on the moral demands posed by the virtues of prudence and justice and allow the Conference to invest wisely and ethically.
You can imagine how these principles might conflict in the real world, which the USSCB acknowledges with a discussion on how to approach “mixed investments”, writing:
One way to be a socially responsible investor is to set limits for corporations engaged in questionable or objectionable activities, to hold a minimal position in those companies that fall under the threshold, and then to use one’s position as shareholder to work actively to influence or redirect the activities or policies of the corporation toward activities and policies which are socially beneficial and serve the common good. Investments of this type may be tolerated, after careful application of the principle of cooperation and the duty to avoid scandal, so long as the Conference engages in active participation and there is a reasonable hope of success for corporate change.”
This approach sounds reasonable, but that’s not how CATH works. CATH does not underweight so-called “mixed investments”; it outright excludes them. Moreover, the threshold for exclusion is not clear. For example, it held Amazon (AMZN), Coca-Cola (KO), and even Altria Group (MO) on December 8, 2022, long after these guidelines were established. It’s also unclear how Las Vegas Sands (LVS) qualified in 2022, as the bulk of its prior year revenues were from its casinos business segment, per its annual report.
While the Index now excludes these stocks, it does highlight the portfolio’s rather lax approach to social investing. Even today, the Index includes CVS Health (CVS), which proudly sells contraceptives, and McKesson (MCK), which distributes them. I’m left to believe that exclusions are allowed so long as they don’t alter the portfolio’s risk and return profile, but I don’t think that’s what shareholders signed up for. Unfortunately, they’re being charged 0.29% per year for minor adjustments that don’t always make sense.
CATH’s 67 Exclusions
The following is a complete list of the 67 stocks CATH excludes, as well as their respective sectors and weights in the S&P 500 Index. As you can see, plenty of Health Care stocks are on the list. If excluding these stocks is important to you, you might want to consider the ProShares S&P 500 Ex-Health Care ETF (SPXV), which has a lower 0.09% expense ratio.
- Amazon (AMZN): 3.67% (Consumer Discretionary)
- Eli Lilly (LLY): 1.54% (Health Care)
- UnitedHealth Group (UNH): 1.12% (Health Care)
- Johnson & Johnson (JNJ): 0.80% (Health Care)
- Merck & Co. (MRK): 0.68% (Health Care
- AbbVie (ABBV): 0.66% (Health Care)
- Walmart (WMT): 0.65% (Consumer Staples)
- Coca-Cola (KO): 0.54% (Consumer Staples)
- PepsiCo (PEP): 0.50% (Consumer Staples)
- Thermo Fisher Scientific (TMO): 0.45% (Health Care)
- Abbott Laboratories (ABT): 0.39% (Health Care)
- General Electric (GE): 0.37% (Industrials)
- Pfizer (PFE): 0.36% (Health Care)
- Philip Morris International (PM): 0.36% (Consumer Staples)
- Danaher (DHR): 0.35% (Health Care)
- Honeywell International (HON): 0.31% (Industrials)
- RTX Corp. (RTX): 0.30% (Industrials)
- Vertex Pharmaceuticals (VRTX): 0.27% (Health Care)
- Regeneron Pharmaceuticals (REGN): 0.24% (Health Care)
- Boeing Co. (BA): 0.23% (Industrials)
- Lockheed Martin (LMT): 0.22% (Industrials)
- Mondelez International (MDLZ): 0.19% (Consumer Staples)
- Bristol-Myers Squibb (BMY): 0.19% (Health Care)
- Altria Group (MO): 0.18% (Consumer Staples)
- CrowdStrike Holdings (CRWD): 0.17% (Technology)
- KKR & Co. (KKR): 0.16% (Financials)
- Target (TGT): 0.15% (Consumer Staples)
- TransDigm Group (TDG): 0.15% (Industrials)
- Becton, Dickinson & Co. (BDX): 0.14% (Health Care)
- General Dynamics (GD): 0.14% (Industrials)
- HCA Healthcare (HCA): 0.13% (Health Care)
- Northrop Grumman (NOC): 0.10% (Industrials)
- L3Harris Technologies (LHX): 0.10% (Industrials)
- GE Vernova (GEV): 0.10% (Industrials)
- Moderna (MRNA): 0.09% (Health Care)
- Agilent Technologies (A): 0.08% (Health Care)
- Centene Corp. (CNC): 0.08% (Health Care)
- Corning, Inc. (GLW): 0.07% (Technology)
- VICI Properties (VICI): 0.07% (Real Estate)
- Hershey (HSY): 0.06% (Consumer Staples)
- Church & Dwight (CHD): 0.05% (Consumer Staples)
- Ventas (VTR): 0.05% (Real Estate)
- Leidos Holdings (LDOS): 0.04% (Industrials)
- GoDaddy (GDDY): 0.04% (Technology)
- Alexandria Real Estate Equities (ARE): 0.04% (Real Estate)
- Jacobs Engineering (J): 0.04% (Industrials)
- Waters Corp. (WAT): 0.04% (Health Care)
- Textron (TXT): 0.04% (Industrials)
- Cooper Cos. (COO): 0.04% (Health Care)
- Everest Group (EG): 0.04% (Financials)
- Las Vegas Sands (LVS): 0.03% (Consumer Discretionary)
- Healthpeak Properties (DOC): 0.03% (Real Estate)
- Celanese Corp. (CE): 0.03% (Health Care)
- Viatris, Inc. (VTRS): 0.03% (Health Care)
- Revvity, Inc. (RVTY): 0.03% (Health Care)
- Bio-Techne Corp. (TECH): 0.03% (Health Care)
- Eastman Chemical (EMN): 0.03% (Materials)
- MGM Resorts (MGM): 0.02% (Consumer Discretionary)
- Charles River Laboratories (CRL): 0.02% (Health Care)
- Universal Health Services (UHS): 0.02% (Health Care)
- Huntington Ingalls Industries (HII): 0.02% (Industrials)
- Catalent, Inc. (CTLT): 0.02% (Health Care)
- Caesars Entertainment (CZR): 0.02% (Consumer Discretionary)
- Wynn Resorts (WYNN): 0.02% (Consumer Discretionary)
- Solventum (SOLV): 0.02% (Health Care)
- Ralph Lauren (RL): 0.01% (Consumer Discretionary)
- Bio-Rad Laboratories (BIO): 0.01% (Health Care)
The exclusions total 17.22% by weight, 7.85% of which are Health Care stocks followed by 3.78%, 2.69%, and 2.17% for Consumer Staples, Consumer Discretionary, and Industrials. That’s it, and CATH merely redistributes the weight to the remaining companies by sector.
CATH Analysis
The following table highlights selected fundamental metrics for CATH’s top 25 holdings, which total 48.29%. Nearly all of the mega-cap stocks you’d expect are included, except for Amazon.
Here are three observations to consider:
1. Excluding Health Care stocks increased the portfolio’s beta, indicating CATH is slightly more volatile than SPY. The same is true for SPXV, but the difference is surprisingly negligible. Most of the added weight flowed into Amgen (AMGN), a stock with a 0.58 five-year beta. According to this statement, the company “has not and does not perform or fund research in the area of human embryonic or fetal stem cells”, so CATH was able to exclude other low-beta Health Care stocks like LLY, UNH, and JNJ without impacting risk too much.
2. CATH also has growth and valuation metrics similar to SPY’s. For example, its weighted average one-year estimated earnings growth rate is 12.50% compared to SPY’s 12.83%, and it trades at 28.18x forward earnings using the simple weighted average method, or 22.43x using the harmonic weighted average method, nearly identical to SPY.
3. SPXV could be the most reasonable alternative to CATH. By design, it excludes Health Care stocks, which account for nearly half of CATH’s exclusions by weight. Its 0.09% expense ratio is more reasonable, and its fundamentals are arguably stronger than SPY. The table reveals slightly higher sales and earnings growth, better earnings momentum (earnings surprises and revisions), and nearly identical profitability. Plus, it’s outperformed both ETFs, delivering a 16.26% annualized return since May 2016 compared to 14.19% and 15.65% for CATH and SPY, respectively.
Investment Recommendation
I don’t recommend CATH because I believe it only applies exclusion criteria when convenient and won’t result in a materially different portfolio from a risk and return perspective. For total return investors, it’s prudent, but for the faith-based investors it’s meant to attract, it’s not ideal. Moreover, it’s hard to accept that 87% (433/500) of the companies in the S&P 500 Index meet the Catholic Church’s moral values threshold, so I view CATH primarily as a closet Index fund with high fees. Stick with SPY as your core large-cap holding, and if you want to avoid companies involved in contraception and stem cell research, SPXV does that by design for a fraction of the cost.