Investing With Your Conscience Has Its Rewards but May Affect Your Bottom Line

By Jeff Brown Special to the Washington Post
Sunday, May 13, 2007; Page F01

The Tradeoff So-called socially responsible investing funds buy shares of companies that support a certain set of values while avoiding companies that do not. During the past five years, such funds have trailed the broader market.

SOURCE: Morningstar | GRAPHIC: The Washington Post - May 14, 2007

Architect Kendall Wilson believes in protecting the environment. When he designs a house or office building, he makes a point of using energy-efficient designs and sustainable materials, such as bamboo instead of oak.

So when Wilson, 50, had his company on its feet and was ready to start building up his retirement savings a few years ago, he wanted his holdings to support his environmentally friendly values. The Alexandria resident and his financial adviser settled on Winslow Green Growth, a mutual fund that owns stock in small companies in the wind power, solar energy and other "green" industries.

"It only made sense for me to invest in some of these things," Wilson said. "It's the right thing to do, and it's at a point where I think these technologies are really going to pan out."

Wilson is one of a growing number of investors seeking balance between the profit motive and hopes of making the world a better place, weighing such issues as the environment and the conflict in Darfur when choosing stocks and mutual funds. The movement involves investors small and large, individuals, foundations, pension funds and other institutions.

Socially responsible investing options have been available for a long time, but their numbers have surged in recent years. Nearly $2.3 trillion was held in socially responsible accounts used by individuals and institutions at the end of 2005, up from $639 billion in 1995 and outpacing growth in total assets invested, according to the Social Investment Forum, a nonprofit organization.

"There is a dramatic increase in the number of investment managers looking at their investments in a different way than they have previously," said Mark Tulay, a director at Institutional Shareholder Services, a proxy advisory firm in Rockville.

But investors often pay a price when they add social considerations to the mix. Socially responsible investing funds, including expenses, generally trail traditional competitors, according to Morningstar data. For the 12 months ended April 30, for example, such funds investing in big-company stocks returned 11.63 percent, compared with 12.28 percent for all big-stock funds. For funds investing in mid-size companies, socially minded versions returned 7.65 percent over the period, compared with 10.24 percent for all funds.

Although individuals and institutions may lose some return to invest according to their principles, many are comfortable with that sacrifice, said Lucy Bernholz, an investing consultant to charitable foundations.

"You may get less of a return, but even if you do, you are putting more into the things you care about," she said.

A Shift in the Climate

Much of the credit for the recent growth in socially responsible investing goes to investors' mounting worry about climate change, according to longtime social-investing advocates.

Peter D. Kinder, president of KLD Research & Analytics, a Boston firm that advises institutions on social investing, said his client list has doubled over the past year.

"We see a very strong interest . . . driven by a deepening awareness of global warming," he said.

For individual investors, there are 131 mutual funds with a social focus, a 134 percent increase from 1996, according to Morningstar. Assets in socially responsible funds top $47.4 billion, a sevenfold increase in the past decade. In the same period, the number of all mutual funds grew by 39 percent while assets nearly tripled.

The classic socially responsible fund avoids stocks in companies engaged in tobacco, alcohol, gambling and weapons production. But there are funds for just about any set of values.

The five Ave Maria Mutual Funds, for instance, follow Catholic teachings, avoiding stocks in companies involved in abortion and pornography or that provide benefits to employees' unmarried partners. The Blue Large Cap Fund favors stocks in companies that give money to Democratic candidates.

Typically, a social fund's manager starts the same way all fund managers do, compiling a list of stocks that fit the fund's investing style -- large-cap growth or small-cap value, for instance. Stocks thought to offer good returns are evaluated according to the fund's social criteria. The manager, for example, may bar shares of any company receiving more than 10 percent of its revenue from tobacco products or seek shares of companies developing clean energy.

The manager's staff can glean this information from corporate filings or rely on data produced by consultants specializing in this kind of research. Some funds, for example, ban stocks in companies doing business in Sudan by using a list maintained by the nonprofit Sudan Divestment Task Force.

Some socially responsible funds are offered by big fund companies such as Vanguard and Fidelity that are better known for their traditional funds. Others come from firms that specialize in social investing, such as Bethesda's Calvert Group, which offers about 15 such funds. A few funds bear a sponsor's endorsement, such as the two Sierra Club mutual funds.

Socially focused funds show up in some 401(k)s and similar workplace retirement plans, but many employers have skipped this option, reluctant to take sides on controversial issues.

Despite its growth, social investing has plenty of critics who argue that selecting stocks by using non-financial criteria undermines returns. And they say there is scant evidence that social investing achieves anything.

"It's like astrology for investors," said Jon Entine, an adjunct fellow at the American Enterprise Institute who has written extensively about socially responsible investing. "It's done by people who are not that sophisticated, by people who have an anti-market bias."

Research shows that socially responsible investors do pay a price, according to Christopher C. Geczy, finance professor at the University of Pennsylvania's Wharton School.

"When you restrict the universe to only those investments that are socially responsible, you are eliminating many, many mutual funds and investment styles that should be in the optimal portfolio," he said, noting there are more than 9,000 U.S. stock funds.

In the recently updated 2003 paper "Investing in Socially Responsible Mutual Funds," Geczy and his colleagues found that investors using actively managed social investing funds achieved annual returns averaging about 3.5 percentage points less than they could have earned with comparable traditional funds. That could significantly reduce one's nest egg in retirement, he said.

But he added that investors do much better with the handful of socially responsible index funds, which lag behind their traditional competitors by only about 0.6 percentage points a year. Unlike actively managed funds, which constantly change holdings in pursuit of hot stocks, index funds simply buy and hold stocks in a market gauge such as the Standard & Poor's 500-stock index. Socially responsible index funds match the selected market barometer but exclude companies contrary to their social goals.

One reason socially responsible funds trail is the extra cost of screening, said Morningstar fund analyst David Kathman.

Many social investing funds did well during the tech boom of the late 1990s but then trailed competitors after that bubble burst early this decade and energy companies took off, Kathman said. That's because social investing screens tend to eliminate polluters like energy companies and to emphasize technology companies because many are considered clean.

Kathman said he could think of only one socially responsible fund good enough to invest in even if one does not care about the social criteria: Amana Growth Fund, which follows Islamic principles banning alcohol, gambling and pork processing. It also shuns financial companies because Islam prohibits charging or paying interest. Though it has cooled a bit in the past 12 months, the fund beat the S&P 500 by more than five percentage points a year over the past decade. Kathman credits talented stock-picking rather than luck.

Many socially minded investors accept that they may get smaller returns.

James Scott, a 60-year-old physician in Portland, Ore., keeps two-thirds of his retirement portfolio in socially responsible funds.

"I'm in the first wave of the boomers," he said. "I kind of grew up in the '60s and always have been for social justice and things like that."

Scott asked a financial adviser to build him a well-diversified portfolio of SRI funds. For starters, that meant no tobacco companies. His returns have been beaten by the S&P 500 by about one percentage point a year, he said.

"I'm okay with that because it makes me feel good about how my money's invested," he said.

Changing the World?

Whether social investing results in changes to corporate policies is the subject of debate.

Theoretically, banning a stock should reduce demand for shares, driving down the price and spurring a company to mend its ways. In fact, social investing, though growing, is too small a niche to have much clout, according to many who have studied it.

"I don't think it has any effect on share prices," said David Vogel, a professor of business ethics at the University of California at Berkeley who has studied social investing. "I think there's very little evidence that it's changing the world. . . . No tobacco firm is going to stop producing tobacco."

Save the Earth Sacrifice Your Returns?

Even the most passionate advocates concede that evidence of success is mostly anecdotal, involving cases like Wal-Mart's decision last year to extend benefits to unmarried partners of employees.

Socially responsible investing will never become popular enough to have a serious impact because most people recognize its flaws, said Entine, arguing that social screens tend to be too arbitrary and simplistic.

A company can get high grades for its charitable work and low grades for some of its products, making the social screen worthless, he said. He noted that socially responsible investors once embraced Enron and other companies that were later embroiled in that scandal. More recently, he said, oil producer BP got high grades for an innovative environmental approach -- until admitting last year that it had failed to adequately maintain its Alaska pipelines.

The debate over whether social investing is appropriate and effective flared anew early this year on reports that the Bill & Melinda Gates Foundation, the world's largest charity, had invested in companies that were causing some of the problems the foundation tries to solve, such as pollution in Africa and predatory lending in the United States.

The foundation takes the view, shared by many others, that its endowment should be invested to produce the most funding for the foundation's causes.

But KLD's Kinder says more foundations and other institutional investors are starting to look for ways to make their investment practices more consistent with their social goals, particularly by using their voting power as shareholders to pressure companies to change.

This spring, companies face 1,114 shareholder resolutions, up from 893 in 1997, according to ISS. While most concern corporate governance, the total includes 45 measures on global warming, up from 36 a year ago -- and none just a few years earlier, Tulay said.

The killings in Darfur also have contributed to institutional investors' growing interest in socially responsible investing, Tulay said. Nine state governments have adopted legislation addressing Darfur. Some, for example, require that state employee pension funds avoid ownership of companies doing substantial business in Sudan.

In a typical case, activist shareholders this spring urged Berkshire Hathaway to sell its $3.3 billion stake in PetroChina, an oil firm whose parent company, controlled by the Chinese government, has extensive operations in Sudan.

But in an example of the uphill battle activists face, that resolution was defeated May 5 by an overwhelming margin. Berkshire Chairman Warren E. Buffett-- who is a Washington Post Co. director -- said there was no evidence that PetroChina itself operated in Sudan or that it had any influence over its parent company.

Because the activist-shareholder approach requires holding shares in the targeted company rather than banning them, it need not entail any sacrifice in investment return, Kinder said.

But even if it does, it may be worth it, he argues. Many investors, whether individuals or institutions, set the issue of effectiveness aside for a simpler goal -- to avoid profiting on businesses they disapprove of, he said.

"If you're a hospital, you really don't want to look yourself in the mirror and say, 'We own a lot of Altria,' " he said, referring to the tobacco company. "It's about what the institution wants to project to the world."