Not long ago, ethical investing was considered an eccentricity or even a joke. No longer. In the first three months of this year, U.S. investors took $13 billion out of conventional stock mutual funds and put $185 million into funds with assets deemed ethically or environmentally responsible. There are now more than 200 such funds. Most are tiny, but 18 have more than $100 million in assets and four have more than $1 billion.
At a time of scandals in business, government, religion, and journalism (just to mention a few large institutions), it’s not hard to understand why people search for ethically pure — or at least not impure — places to put their money. And, as it turns out, you can have your ethical cake and eat it, too.
The Domini 400 Social Index, which tracks the performance of companies that pass a series of moral screens, returned an annual average of 9.64 percent for the 10 years ended April 30. The return of the benchmark Standard & Poor’s 500-stock index over this period was almost precisely the same: 9.66 percent.
Similarly, in Britain, 100 pounds invested in the stocks that make up FTSE4Good, an index of socially responsible companies included in the benchmark FTSE 400 index, rose to 319 pounds after 10 years. The same investment in the Money Observer Sindex — that is, firms excluded from the FTSE4Good — rose to 318 pounds.
Overall, $13 billion is invested in U.S. public mutual funds that focus on socially responsible investing, or SRI. That’s about one-half of 1 percent of total mutual fund assets, but it understates the impact of this kind of investing, since far more money (though it’s impossible to say how much) is invested worldwide in privately managed SRI accounts.
“More than 800 independent asset managers identify themselves as managers of socially responsible portfolios for institutional investors and high-net-worth individuals,” says a recent article in Across the Board, the magazine of the Conference Board. And monitoring corporate ethical and environmental performance has become a growth industry.
But there is one enormous problem with SRI. Ethics, social responsibility, environmental stewardship — whichever terms you want to use — are exquisitely personal. How can an index or a mutual fund or a financial adviser tell you what’s moral and what’s not?
The Social Investment Forum, a kind of clearinghouse for information about SRI, states, “Integrating personal values with societal concerns is called ‘socially responsible investing.’ ” Well, yes. But what do all those words mean, exactly?
Different people have different notions. For example, an organization called SAM Research, based in Zurich, has worked out a complicated rating system for global corporations based on a questionnaire that assesses 22 attributes, including corporate governance (which gets a 5.4 percent weighting in the final score), environmental management (3 percent), and employee satisfaction (1.2 percent). The five or six companies that get the highest marks from SAM in each of 59 economic sectors are anointed members of the Dow Jones Sustainability Index, which was started in 1999 and is updated each year.
Components include Novozymes, a Danish company that manufactures enzymes that make water cleaner; Intel (INTC), the U.S. semiconductor maker; Pearson (PSO), the British media and education company that publishes the Financial Times; and Westpac Banking (WBK) of Australia.
The Domini index has another approach. It automatically excludes companies that make alcohol, tobacco, or firearms; that offer gambling or operate nuclear power plants; or that earn “2 percent or more of sales from military weapons.” Analysts at Kinder, Lydenberg, Domini, which compiles the index, also bump companies with poor records on “the environment, diversity, employee relations and product.”
In my view, companies that make weapons that help defend the United States are doing a good thing, not a bad thing. Also, I think that nuclear power is a clean, efficient way to produce electricity that improves people’s lives, and that gambling is a completely legitimate means of entertainment for adults. But that’s just me. Other investors disagree, of course. Why, however, would anyone want to own a mutual fund like Domini Social Equity (DSEFX), which is based on the index itself and eliminates stocks based on Domini’s judgment of what’s ethical?
But a lot of people own such funds. Domini had, at last count, $1.2 billion in assets — up from just $69 million in 1995. Another popular SRI fund, Dreyfus Premier Third Century (DRTHX), which eliminates companies judged to have poor records on the environment and worker safety, has $565 million in assets. Parnassus (PARNX), started in 1985 and one of my longtime favorites, has whipped the S&P soundly over the past five years and manages $300 million.
Another large fund, Calvert Social Investment Fund Equity (CSIEX), part of a large family of ethical funds based in Bethesda, Md., uses Domini-like criteria and, according to Morningstar, “just started to screen on corporate-governance issues that include such items as executive compensation and shareholder involvement.”
Despite what appear to be tough-minded criteria, Domini, which is the dominant index, influencing many of the funds, eliminates surprisingly few large companies. The biggest include Altria (MO), which soared last week on news of a court victory by its Philip Morris tobacco division; Exxon Mobil (XOM), the world’s largest energy company; Boeing (BA), which makes combat and commercial aircraft; and General Electric (GE), the company with the largest market capitalization in the world. GE’s apparent offenses include manufacturing engines for military jets and turbines for nuclear plants. It seems to get no offsetting credits for making computer-tomography scanners that find disease unobtrusively.
Domini’s portfolio closely resembles its starting universe — the S&P 500 — explaining why its results vary from that index by only a point or two either way each year. The Calvert fund, whose managers have more leeway, produced terrible returns between 1993 and 1998, trailing the S&P in every year — and four times by more than 13 percent. Calvert Social, in fact, was typical of SRI funds of that early generation. It was poorly managed.
Performance improved sharply when the firm hired Daniel W. Boone in late 1998. Since then, the fund has returned an incredible average of 11 percent annually — at a time when most investors were doing well just to break even.
Boone is so good that you may want to own the fund whether you care about SRI or not. The one drawback is that the fund’s A shares carry a 4.75 percent load and annual expenses of 1.3 percent. (How socially responsible is that?) Boone’s top three holdings at the end of April were Cisco Systems (CSCO), Internet infrastructure; American International Group (AIG), insurance; and WellPoint Health Networks (WLP), managed care.
There’s another approach to social investing, described by Michael Prowse of Britain’s Financial Times: The role of the corporation “is to provide individuals with the means to be socially responsible.”
“Rather than trying to play the role of social worker, senior executives should concentrate on their statutory obligations. We should not expect benevolence of them, but we should demand probity.”
In other words, don’t invest in companies run by liars and cheaters, but feel free to buy tobacco and liquor stocks even if you disapprove of what they do for a living. Make as much money as you can however you can do it, and give it to charity. Just like Andrew Carnegie.
But for investors who simply don’t want to put their money in companies they consider tainted, there’s another choice that’s far better than standard mutual funds. Foliofn offers prepackaged portfolios, typically of 30 stocks, selected by computer or an outside authority. Investors can then adjust each portfolio any way they want, eliminating some stocks, adding others.
The firm has six ready-made SRI portfolios: Environmentally Responsible, Labor Friendly, Minority Leaders (highest percentage of minority board members), SRI Large-Cap, Tobacco Free, and Women Leaders (tops in female board members).
You can start, for example, with the 30 stocks of SRI Large-Cap, which were selected using criteria set by the Investor Responsibility Research Center, similar to Domini’s screens. Then, if you can tolerate weapons makers, add Lockheed Martin (LMT) or Boeing. Or, if you think the portfolio is top-heavy in financials (as it seems to be, with 17 stocks), you can eliminate Wachovia (WB), Wells Fargo (WFC), and a few more.
Or you can simply go with the entire ready-made Minority Leaders Folio, which includes stocks nixed by other SRI funds, such as Anheuser Busch (BUD) and General Motors (GM).
For the six months ending May 21, Minority Leaders was up 16 percent while the S&P was down 1 percent.
That may be a fluke. On the other hand, it seems that a diversified, personalized SRI portfolio can salve your conscience — if you need that sort of thing — without sacrificing overall returns. Now there’s a deal.
— James K. Glassman is a fellow at the American Enterprise Institute and host of TechCentralStation.com. Among stocks mentioned in this article, he owns General Electric and Exxon Mobil. This column originally appeared in the Washington Post.