March/April 1999

Are 'Socially Responsible' Mutual Funds for You?

So you're about to get your tax refund and you've decided to bet on the market. Which mutual funds should you choose?  For an increasing number of investors who want to exercise their social conscience, there is the added lure of 'socially responsible' or 'ethical' investing.

For the uninitiated, SRI involves applying social screens to companies to identify corporate good and bad guys.  It caught on in the 1980's as a way to avoid investing in companies that had a presence in apartheid South Africa.  Then came the tobacco industry boycott. SRI funds now focus on a spectrum of social and political issues.   According to a recent survey, the top negative screens are tobacco, gambling, military production and alcohol. The leading positive screens are abortion rights, environmental issues, human rights and animal welfare.

Are SRI mutual funds for you?

Well here's a vote against them.  It's not that I oppose the intentions of these funds, which according to the SRI mantra is to "do well by doing good."   And it's not performance.  Investment professionals knock SRI funds assuming that screening out high-profit oil polluters and the like drags down portfolio performance.  In fact, numerous studies have shown that our vast investment marketplace ensures that social screens have no effect one way or another.  Last year for example, Dreyfus' Third Century, Domini Social Index and Citizens Trust Index, all growth funds, topped the S&P 500 Index, mostly by betting heavily on technology.

So what's my beef?  In practice, SRI mutual funds are a marketing gimmick.  The sobering reality is that they may promote corporate behavior that is neither progressive nor ethical.

On the surface, these funds offer something for everybody.  Catholics can choose the Aquinas Fund and Muslims the Islamia Fund. Concern about the environment?  There are dozens of funds.  For gay and Lesbian rights? Choose Meyers Pride Fund.  Against "the homosexual lifestyle?"  Choose the Christian fundamentalist Timothy Plan.  An Internet search turns up more than 100 such funds, from military-hating Pax World, to animal-rights protector Beacon Cruelty-Free Value, to Women's Pro-Conscious Equity Fund.

Investors have so far poured about $100 billion into SR funds, less than 1 percent of the market.

It's an appealing investment strategy until one asks probing questions.  What constitutes 'socially responsible' behavior.  The concept has become associated with a set of static beliefs drawing on 1960's notions of liberal propriety and correctness.   For the most part, these
are not screens but social litmus tests.

For instance, many SRI funds will not invest in defense contractors. Why?  Their response is no more sophisticated than "weapons are bad."  As someone who had relatives killed during the Holocaust, and was grateful for US military prowess during two conflicts with Iraq, screens on military production in the name of ethics is offensive; it may even undermine the pro-active goal of curtailing unnecessary defense expenditures.  The tougher question is:  Which companies are involved in the kind of military research or production that offers a better hope for peace?

"Getting a comprehensive, meaningful screen is next to impossible," says a skeptical William Martello, assistant professor of policy and environment Loyola Marymount University.  "Concerns like nuclear power and defense spending are not issues of social responsibility but political statements.  These are idiosyncratic ideological filters, not ethical screens."

Consider animal testing.  Which companies act more responsibly:

-- Gillette and Procter & Gamble, which have extensive research laboratories, perform expensive, FDA-required safety tests, have pioneered (at considerable company cost) the development of alternatives to animal testing, and in the case of Gillette, publishes for public scrutiny the rationale for every one of its tests; or

-- Stonyfield Farm, Aveda, Tom's of Maine, and other new-age companies which tout their "cruelty-free products," yet use animal-tested ingredients (developed by their competitors, not them) and have spent almost nothing to fund alternative research, all the while earning a pricey green premium for their lofty, moral rhetoric?

Despite being caricatured by the SRI community, controversial multinationals such as Monsanto, DuPont, or Exxon offer fair wages and benefits, have impressive affirmative-action practices, address complicated environmental issues, give many millions of dollars to charity, and sell competitively-priced products and services.   According to the SRI litmus tests, that does not make them ethical or socially responsible.  They have to wear their heart on their sleeves to make the cut.

I'll choose honesty in the gray world of reality than posturing any day. Scientists at Gillette do not go to bed at night dreaming of pouring caustic chemicals into the eyes of fluffy white bunny rabbits.  Critical investors should react to facile sloganeering, even by "well meaning" companies, in the same way as if Microsoft or Pepsi put "against animal testing" on their labels.

After you get past hyperbolic claims about "changing corporate behavior," there is not much evidence that SRI funds do much good.  "The ethical funds movement is just fooling itself," says John Bishop a business ethics professor.   "Investors might feel good, but capital markets are like a swimming pool.   Ethical investing, even if you assume that the screens make sense, are less than 1 percent of the market.  It's like taking a bucket of water out of the shallow end and emptying it in the deep end."

Am I suggesting that investors should just go for high return, ethics be damned?  Not at all.  Just don't deceive yourself.  Buying and selling stocks does not bring social justice.  Most SRI funds, whatever might be their proponents intentions, are little more than a feel-good exercise, not unlike buying ice cream made with nuts from the Amazon rainforest and convincing yourself that you're helping the world.  That's nothing more than baby boomer narcissism.