May 2008
Principles vs. performance
Socially responsible funds let your conscience be your financial guide. But you might have to settle for lower investment
returns
With the Standard and Poor’s 500 losing almost 10 percent in the first quarter of 2008, this might seem like a curious time
to look at funds that follow socially responsible investment (SRI) principles. After all, it’s hard enough to make a profit
in today’s market, and the common wisdom is that you’ll pay a premium to invest in companies with a conscience. When we examined
the sector for the Consumer Reports Money Lab, we found that to be largely true in recent years. However, we found a few funds
that did well for investors while also doing good.
Screening criteria differ
SRI funds come in many colors. Some adhere to religious principles; others seek to promote certain social or environmental goals. Traditionally they have employed two basic screens. Negative screens filter out companies whose products or behaviors might be considered harmful to health, society, or the environment. They may also prohibit investing in companies that engage in practices that violate certain religious strictures, such as the Islamic objection to charging interest. Positive screens, naturally, look for investment opportunities that benefit humankind and the environment. Most funds use a combination of the two screens, which are placed atop a more traditional financial screening framework, such as screening for value among large-cap stocks.
As you might suspect, one manager’s notion of a company that’s socially responsible may differ from another’s, or, more important, yours. Look hard enough and you can find a fund that, although it considers itself socially responsible, invests in tobacco. Similarly, some funds will screen out companies that, say, focus on renewable energy because their employee-benefits packages are deemed inadequate. Still other funds are relativists. They’ll invest, for instance, in an oil or oil-services stock if it’s also doing positive work in environmental conservation. Screening can get murkier still. For example, is an airline, despite its progressive hiring practices, a socially responsible investment when it leaves a huge carbon footprint?
Only you can answer those questions, of course. But it’s a good idea to look beyond a fund’s name and claims to see if it meets your criteria for sound investing, either financially or socially.
SRI funds now manage over $200 billion, according to the Social Investment Forum, an association of SRI professionals. That’s more than twice as much as 10 years ago. Growth hasn’t kept up with the mutual-fund industry as a whole, which now manages nearly three times as much as it did in 1997. But there are a lot of SRI funds to choose among. By one count, there are more than 200. Morningstar, the Chicago-based investment research company, identifies 95 stock SRI funds.
Assessing the trade-off
SRI funds have long suffered from the notion that their investors are essentially trading off the highest possible return for a social good. The Consumer Reports Money Lab examined Morningstar’s group of 95 equity funds to see if that trade-off really existed and, if so, how much it cost (see The cost of conscience.) We found some general characteristics of the group that can help explain why performance differs from the larger universe of U.S. diversified equity mutual funds.
For example, SRI funds tend to invest more in consumer and business services (think Target and Google) and less in energy and consumer goods (such as ExxonMobil and Anheuser-Busch). With oil companies reporting record profits, one might expect that the underexposed SRI funds would have underperformed recently compared with equity funds as a whole. And our analysis bore this out: In the past five years, SRI funds returned 11.1 percent annually, while all domestic equity funds returned 14.5 percent (see Responsible winners). And only 15 percent of SRI funds with a five-year track record returned more than that.
Turnaround under way?
More recently, however, the picture appears to be changing. In the first three months of this year, SRI stock funds beat all domestic equity funds by a tiny bit (though both groups lost money). And when compared with a narrower index, the S&P 500, more SRI funds beat it instead of lagging behind it.
Those two gauges underscore the point that as the business cycle changes, so too will the fortunes of SRI funds relative to the broader market. When energy and utility stocks—two sectors avoided by many socially responsible funds—were booming earlier this decade, it was quite difficult for most SRI funds to keep pace with the broader market without exposure to these two options. Yet recent data suggest that, strictly on a total return basis, SRI funds might now be a good place for your equity investments. While a single calendar year or quarter isn’t concrete evidence of a turnaround, it at least proves that SRI funds aren’t chronic underperformers. Moreover, results from a recent study of U.K. SRI funds indicate that socially responsible investing can indeed outperform over the long haul.
Expenses take a toll
Fund expenses are another factor affecting returns. SRI funds generally have higher fees and expenses than the typical mutual fund. We found only 20 publicly available SRIs with expense ratios of less than 1 percent—quite pricey for a group of mostly large-cap funds. Exchange-traded funds, which trade like stocks and have low expense ratios, are beginning to change the landscape. There are now more than a dozen socially or environmentally screened ETFs. All of them have expense ratios of less than 1 percent, and average about 0.50 percent. As a result, good do-it-yourself investors might easily build their own SRI portfolio based on selecting the industries that pass their own screens of social responsibility.
In Responsible winners, we’ve highlighted five mutual funds that mostly outperformed their benchmark indexes over the last five years following different paths of social responsibility. We’ve also included one of the better socially responsible ETFs.
The Parnassus Equity Income and Neuberger Berman Socially Responsive funds focus on how companies treat their employees and the environment. Two other selections, New Alternatives and the Market Vectors Environmental Services ETF, concentrate on the environment. The Timothy Plan Large/Mid Value fund avoids buying companies involved in practices it deems contrary to Judeo-Christian tenets. Another religious fund, Amana Growth, is guided by Islamic principles.
Screening criteria differ
SRI funds come in many colors. Some adhere to religious principles; others seek to promote certain social or environmental goals. Traditionally they have employed two basic screens. Negative screens filter out companies whose products or behaviors might be considered harmful to health, society, or the environment. They may also prohibit investing in companies that engage in practices that violate certain religious strictures, such as the Islamic objection to charging interest. Positive screens, naturally, look for investment opportunities that benefit humankind and the environment. Most funds use a combination of the two screens, which are placed atop a more traditional financial screening framework, such as screening for value among large-cap stocks.
As you might suspect, one manager’s notion of a company that’s socially responsible may differ from another’s, or, more important, yours. Look hard enough and you can find a fund that, although it considers itself socially responsible, invests in tobacco. Similarly, some funds will screen out companies that, say, focus on renewable energy because their employee-benefits packages are deemed inadequate. Still other funds are relativists. They’ll invest, for instance, in an oil or oil-services stock if it’s also doing positive work in environmental conservation. Screening can get murkier still. For example, is an airline, despite its progressive hiring practices, a socially responsible investment when it leaves a huge carbon footprint?
Only you can answer those questions, of course. But it’s a good idea to look beyond a fund’s name and claims to see if it meets your criteria for sound investing, either financially or socially.
SRI funds now manage over $200 billion, according to the Social Investment Forum, an association of SRI professionals. That’s more than twice as much as 10 years ago. Growth hasn’t kept up with the mutual-fund industry as a whole, which now manages nearly three times as much as it did in 1997. But there are a lot of SRI funds to choose among. By one count, there are more than 200. Morningstar, the Chicago-based investment research company, identifies 95 stock SRI funds.
Assessing the trade-off
SRI funds have long suffered from the notion that their investors are essentially trading off the highest possible return for a social good. The Consumer Reports Money Lab examined Morningstar’s group of 95 equity funds to see if that trade-off really existed and, if so, how much it cost (see The cost of conscience.) We found some general characteristics of the group that can help explain why performance differs from the larger universe of U.S. diversified equity mutual funds.
For example, SRI funds tend to invest more in consumer and business services (think Target and Google) and less in energy and consumer goods (such as ExxonMobil and Anheuser-Busch). With oil companies reporting record profits, one might expect that the underexposed SRI funds would have underperformed recently compared with equity funds as a whole. And our analysis bore this out: In the past five years, SRI funds returned 11.1 percent annually, while all domestic equity funds returned 14.5 percent (see Responsible winners). And only 15 percent of SRI funds with a five-year track record returned more than that.
Turnaround under way?
More recently, however, the picture appears to be changing. In the first three months of this year, SRI stock funds beat all domestic equity funds by a tiny bit (though both groups lost money). And when compared with a narrower index, the S&P 500, more SRI funds beat it instead of lagging behind it.
Those two gauges underscore the point that as the business cycle changes, so too will the fortunes of SRI funds relative to the broader market. When energy and utility stocks—two sectors avoided by many socially responsible funds—were booming earlier this decade, it was quite difficult for most SRI funds to keep pace with the broader market without exposure to these two options. Yet recent data suggest that, strictly on a total return basis, SRI funds might now be a good place for your equity investments. While a single calendar year or quarter isn’t concrete evidence of a turnaround, it at least proves that SRI funds aren’t chronic underperformers. Moreover, results from a recent study of U.K. SRI funds indicate that socially responsible investing can indeed outperform over the long haul.
Expenses take a toll
Fund expenses are another factor affecting returns. SRI funds generally have higher fees and expenses than the typical mutual fund. We found only 20 publicly available SRIs with expense ratios of less than 1 percent—quite pricey for a group of mostly large-cap funds. Exchange-traded funds, which trade like stocks and have low expense ratios, are beginning to change the landscape. There are now more than a dozen socially or environmentally screened ETFs. All of them have expense ratios of less than 1 percent, and average about 0.50 percent. As a result, good do-it-yourself investors might easily build their own SRI portfolio based on selecting the industries that pass their own screens of social responsibility.
In Responsible winners, we’ve highlighted five mutual funds that mostly outperformed their benchmark indexes over the last five years following different paths of social responsibility. We’ve also included one of the better socially responsible ETFs.
The Parnassus Equity Income and Neuberger Berman Socially Responsive funds focus on how companies treat their employees and the environment. Two other selections, New Alternatives and the Market Vectors Environmental Services ETF, concentrate on the environment. The Timothy Plan Large/Mid Value fund avoids buying companies involved in practices it deems contrary to Judeo-Christian tenets. Another religious fund, Amana Growth, is guided by Islamic principles.
