BusinessWeek Investor: Mutual Funds
A Conscience Doesn't Have to Make You Poor
Funds with heart are racking up dandy returns
Marco Kaltofen, 40, believes there are earthly rewards for doing good. An environmental engineer in Cambridge, Mass., Kaltofen says: "I see the damages that many companies do to people's health and the environment by polluting or creating dangerous products. Investing in them makes no sense because these companies won't flourish in the long run." So Kaltofen, who makes his 34-mile round-trip commute to the office by bike, invests only in mutual funds that boycott companies with poor environmental records. His choices: Citizens Global Equity, Domini Social Equity, Green Century Balanced, and Pax World. "You don't have to sacrifice return for your values," he says.
Kaltofen hasn't suffered. Last year, his mutual fund portfolio returned 55%. That's in sharp contrast to the image of socially responsible mutual funds as mediocre performers. These funds, whose investments reflect the views of various groups, from gay rights supporters to conservative Christians, "used to be the laughingstock of the mutual-fund industry," says Emily Hall, an analyst at Morningstar. "People thought of them as lacking business sense." But over the past two years, many do-good funds have shot to the top of the performance charts--although they've hit a rough patch this past month. Their longer-term performance isn't due to specific social or religious goals, but to the funds' heavy slugs of tech stocks. Technology companies, which don't make "sin" products like tobacco or booze, are the most politically correct investments around. "Everyone can agree that there is nothing immoral about technology," says Arnold Abens, a financial adviser in Edina, Minn.A TECHNOLOGY ROUT. Some socially responsible funds hold 60% or more of their assets in tech stocks and thus have closely tracked this volatile sector. Of the 54 socially responsible funds followed by Morningstar, 11 rose 50% or more during the 12 months ended Mar. 31. Among them: Green Century Balanced, up 151%; Dem Equity Institutional, up 140%; and IPS Millennium, up 107%. But the plunge in technology stocks since their Mar. 10 peak have caused some socially responsible funds to lose as much as 40% of their value.
The tech rout aside, the reputation of socially responsible funds has been on the rise. The proof is that Vanguard, the second-largest fund company, and TIAA-CREF, the huge teachers' pension providers, have entered this field. TIAA-CREF launched the Social Choice Fund for retail investors Apr. 3. Vanguard, meanwhile, will start the Vanguard Calvert Social Index Fund May 8. The Vanguard offering will invest in large-company stocks selected by Calvert Group, a fund company whose forte is socially responsible investing from a liberal outlook. These newcomers are a welcome addition to the genre because they keep expenses to a minimum: TIAA-CREF's fund boasts a 0.27% expense ratio, while Vanguard's will offer an even lower 0.25%. The average expense ratio for the category is 1.5%.
These mainstream fund companies are hoping to capture some of the increasing investment flows into socially responsible funds. In the two years that ended on Nov. 31, assets in these funds swelled from $96 billion to $154 billion, and the number of fund offerings jumped from 139 to 175, according to the Social Investment Forum, a nonprofit group in Washington that promotes socially responsible investing. Mutual funds, however, are only a small part of the socially responsible investing world. The Social Investment Forum figures the total amount of money under socially responsible management stood at $2.16 trillion in November, 1999, up 82% from $1.2 trillion two years earlier. Their total represents 13% of the $16.3 trillion under professional money management in the U.S.
Improved performance isn't the only reason do-good investing is catching on. Thanks to the longest bull market in history, investors are richer and thus more reflective, says Steve Schueth, president of First Affirmative Financial Network, a financial advisory firm in Colorado Springs that focuses on socially responsible investing. Increasingly, he says, people want their wealth to help others. Financial planner Abens believes socially responsible investing resonates with baby boomers at a time when they are reaping inheritance windfalls. "Boomers are burying their parents and thinking about what will be on their own tombstones," he says.
Are socially responsible mutual funds right for you? Finding one that reflects your values will take digging. Most funds filter out companies involved with tobacco, alcohol, and gambling--the classic sin stocks. But there is little consensus on what other screens are appropriate. In part that's because the funds are geared to groups with different aims. Funds with a liberal outlook, such as those managed by the Calvert and Domini groups, tend to shun companies that harm the environment, make arms, generate nuclear power, or employ child labor. Other funds have more narrowly focused mandates. The Myers Pride Value Fund, for instance, avoids companies that discriminate against homosexual employees while investing in companies that promote gay rights. At the other end of the spectrum are the Timothy Plan funds. Reflecting the view held by some conservative Christians that homosexuality is morally wrong, the funds boycott companies that provide health benefits to the partners of gay employees. Timothy Plan funds also avoid companies that profit from pornography and abortion. Other religious groups, including Roman Catholics, Christian Scientists, Mennonites, and Muslims, also have funds designed to reflect their beliefs. Among them: the Islamic fundamentalist Amana funds, which avoid financial stocks in keeping with the Islamic prohibitions against interest.
Socially responsible funds also differ in how they screen. Some funds, such as TIAA-CREF's Social Choices, stick to what are called negative screens, meaning that they avoid investments in companies engaged in objectionable activities. But other funds additionally employ another layer of "positive" screens, which involves directing investment dollars to companies whose practices the fund applauds, such as hiring women and minorities. Green Century funds, for instance, invest in companies that promote alternative energy. Some funds, including those run by Calvert and Domini, go a step further and engage in shareholder activism. A fund will buy shares in a company that passes its screens but still has some offending practices. The fund then tries to effect change via proxy votes or other methods.
Several Web sites can help you search for a fund that fits your values. The Social Investment Forum's www.socialinvest.org lists 59 funds and indicates which of 12 different screens each fund employs. The site also provides links to funds' Web sites. At www.domini.com, you'll find the fund group's social screening criteria and proxy voting guidelines. Co-Op America's Web site, www.coopamerica.org, provides an overview of socially responsible investing and lists different screens that funds employ. SocialFunds.com, at www.socialfunds.com, lets you search for socially responsible funds by category, ask questions on investor bulletin boards, find news articles on companies with good and bad social policies, and obtain details on individual fund performance.GOOD AND BAD. A fund's prospectus will provide detailed data on screening procedures. But it's also important to check the companies that a fund invests in to make sure that you don't find them objectionable. You can find a fund's top investments by checking Morningstar's Web site at www.morningstar.com. The Domini Social Equity Fund counts Wal-Mart Stores among its top five holdings because of the retailer's outstanding environmental record and its generous stock purchase plan for rank-and-file employees. But Wal-Mart is also a leading retailer of guns, a practice that might make some investors uneasy. Similarly, health-conscious investors might object to Coca-Cola, another top holding in the Domini Social Equity Fund (page 208).
Be sure to check the fund's technology weighting. "Most people don't associate socially responsible funds with high risk," says Abens. "But many socially responsible funds today are really aggressive technology funds." While you might have been delighted to own a fund overweighted in tech when that sector was booming, the market's recent downturn might make you feel differently. One example: IPS Millennium, which has nearly 70% of its assets in technology stocks, lost 40% of its value between Mar. 10, when tech stocks peaked, and Apr. 14. During that period, the tech-laden Nasdaq Composite Index dropped 34%.
Kaltofen, the environmentalist, says he isn't losing sleep over the declines his tech-heavy funds have suffered recently. "I'm a long-term investor, so nothing has changed for me," he says. However, if you find you don't have the stomach for roller-coaster rides, look for a broadly diversified fund in the socially responsible category. One option: TIAA-CREF's Social Choices fund closely follows the industry sector weightings of the Standard & Poor's 500-stock index.
In the end, you may conclude that the only social responsibility a business has is to maximize profits. If that's the case, you can still do your part by donating some of your dough to charity. But even if you want your investments to do double duty on both the profit and moral fronts, you still may have to compromise. After all, says Schueth, "no company is perfect."By Susan ScherreikReturn to top