Fresh Look at Socially Responsible Mutual Funds
Most socially responsible mutual funds are born of a desire to help the environment, slow the spread of violence, or boycott certain practices. Parnassus Workplace (PARWX), on the other hand, sprang from between the covers of Fortune magazine.
Several years ago,
Operating under that premise, Dodson launched Parnassus Workplace in 2005. Since then, the fund, which invests exclusively
in companies that treat their employees well, has consistently trounced the competition, and it is currently the top-ranked
A number of other socially conscious funds join Parnassus Workplace atop the
Taken together, these funds hint at a shifting landscape for socially responsible investing (SRI), even as the debate rages on over the wisdom of mixing morality with stock picking.
All too often, it seems, this debate moves toward the extremes. Socially responsible investors, for example, are portrayed either as clueless amateurs or forward-thinking geniuses. And their portfolios, in turn, are labeled as everything from hopelessly restrictive to deceptively insightful.
In the process, the most fundamental of questions often go unanswered: Do social screens harm performance? Under what circumstances will a socially responsible fund outperform the market? And what changes are on the horizon for this style of investing?
Broadly defined, socially responsible funds can focus on anything from religion to the environment to pacifism. By style, they can invest in large-cap stocks, small-cap stocks, bonds, and anything in between. Given this wide range, there's no ideal way to track the performance of SRI funds as a group.
Still, there are some adequate proxies. A
A final way to quantify the performance of SRI funds is through measures like the FTSE KLD 400 Social Index, which tracks the returns of stocks that are attractive to investors concerned about environmental, social (excluding religious), and governance issues. The index has one-, three-, and five-year returns that beat the
At the same time, there are a number of far less positive indicators for SRI funds. Alternative energy funds, for instance, got crushed in 2008 and generally didn't rebound nearly enough last year to erase the damage.
A new model?
Common wisdom holds that the more restrictions a fund has, the more difficult it is for it to consistently perform well. By that measure, SRI funds, which aim to screen out not only financially unsound investments but also investments that are socially or ethically objectionable, start at somewhat of a disadvantage. "There are certainly investments that could generate a strong financial return that we've taken a pass on," concedes
But increasingly, there are signs that a new generation of SRI funds is emerging, one that thinks of screens not as a net neutral or even as a potential hindrance but instead as a successful investing strategy. This new strain is perhaps most evident in the environmental arena, where the combination of innovation and a softening of public opinion has paved the way for funds to benefit from their focus on green investing. A recent survey by
Then there are funds like Parnassus Workplace. On its surface, the fund's concern for strong workplace environments appears to be exclusively ethical. But in reality, Dodson's decision to invest only in those companies that provide superior conditions for workers is much like the choice a manager would make to buy a stock only if it's trading at a certain valuation. In other words, it's a self-imposed restriction, but one that is ultimately aimed at making money. "If you have a happy workforce--people that like the company, that feel they're being treated fairly--I think they're going to work harder. And in today's economy . . . you really need a motivated workforce," says Dodson.
Accidentally on purpose. It goes without saying that most large-cap funds, regardless of the talent of their management, will get a boost when blue chips rally. Meanwhile, if big-name stocks fall out of favor, there is little that a large-cap fund can do to buck the trend. The same goes for sector funds when a given type of investment is either rising of falling.
Surprisingly, investors tend to overlook the fact that similar dynamics influence SRI funds. In other words, even if they are not explicitly sector-specific investments, SRI funds are often driven toward or away from certain parts of the market by the nature of their screens.
In 2008, for example, Amana Trust Income (AMANX) made the superficially prescient move of completely avoiding financials. And as financial stocks tanked and battered the returns of Amana's competitors, the fund easily made it into the top percentile of
Similarly, the Ave Maria funds, which cater to Christian investors, are not allowed to own "companies that support abortion in any way," says comanager
These accidents of chance are perhaps even more likely to materialize in the future as SRI funds begin to screen not only for the absence of certain factors but also for the presence of others. The
"You traditionally think of social screening . . . as them coming up with a list of things that they can't own--like alcohol, tobacco, gambling stocks, weapons stocks, or things like that," says Kathman. "But there's been this tendency among a lot of SRI funds in recent years to have it be more positive screening, where they're looking for companies that have these positive attributes that they want to see."
In some ways, this is just a question of semantics. A fund that looks exclusively for "positive" indicators like support for human rights, for instance, is unlikely to invest in a weapons company, even if the fund doesn't explicitly screen out firearms producers.
Still, as SRI funds continue to feel pressure not only to avoid the bad but also to actively seek out the good, there is a chance that they will become increasingly concentrated in various sectors. This, in turn, will open them up to a host of sector dynamics that, for better or worse, are beyond their control.
The long haul. Since socially responsible funds are a relatively new phenomenon, one of the biggest uncertainties is how they will fare over sustained periods. The question then becomes: What types of SRI funds stand the best chance of delivering solid long-term results?
The most tempting answer is that the most flexible funds will hold up the best. All SRI funds have some restrictions, but some obviously have their hands tied much more than others. As such, it seems reasonable to conclude that the funds that are most able to move in and out of sectors as the market demands are the ones that will get the best results.
But of course, there are also far more mundane factors at play. In fact, sometimes the biggest edge one fund can have over the other is its price tag. That's particularly true with SRI funds, which tend to be some of the more costly investments on the market.
"A lot of these funds tend to be . . . expensive," says Kathman. "And that has more of an effect on returns than any SRI screens [have]."
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