Sickened by corporate scandals, spooked by negative earnings surprises and unsure where the economy is headed, investors recently have been pulling their money out of stock funds. But one type seems to be weathering the redemption storm a little better: socially conscious stock funds. According to data from Lipper, a subsidiary of Reuters that tracks fund flows and performance, $51.7 billion flowed out of U.S. diversified equity funds in June, July and August. Of that, a record-breaking $35.6 billion hemorrhaged in July alone. Socially conscious equity funds actually had positive inflows in June and August, but lost $120 million in July. From December 31 to August 31 (the latest month for which figures were available at press time), total net assets of U.S. diversified equity funds dropped 18.3% to about $1.97 trillion, Lipper says. By contrast, Lipper data shows total net assets of socially conscious equity funds dropped only 3.4% to approximately $11.37 billion. Tom Roseen, a Lipper research analyst, says observers must be careful not to overstate what the numbers mean. "But when a person has a conviction to go into a particular type of fund, whether it's based on Catholicism or Islam or whatever, there is some stickiness. They know that's the only alternative." Anita Green, director of social research at Pax World Funds in Liberty, Mo., believes the general public is angry over the flagrant corporate abuses that have surfaced over the last year. And she thinks that has made more investors turn to socially responsible investing (SRI). "I do think it's a reaction," she says. "I don't have scientific evidence, but I think there is a link." Timothy Smith, president of the Social Investment Forum, the national trade association for the SRI industry, says it's hard to pinpoint why socially conscious equity funds seem to be doing a better job at holding on to assets than U.S. equity funds as a whole. "But at least my sense, as president of the forum, is that numerous individuals are distressed by scandals and concerned as their portfolios have rapidly decreased. They're looking for managers committed to the double bottom line-financial returns and social returns," says Smith, who also is senior vice president at Walden Asset Management, a Boston firm that manages $1.3 billion in separate accounts for individuals and institutions. But can socially conscious vehicles, sometimes derided as politically correct funds, perform as well as other equity funds? Socially conscious equity investments are competitive with other classes, but they certainly haven't escaped the bludgeoning other equity funds faced over the last few years with the bursting of the stock market bubble. Lipper says that as of September 30, the cumulative total return of socially responsible equity funds was -26.63% for the first nine months of 2002, -17.1% over the last year, -9.19% for the last three years and -1.64% over the last five years. U.S. diversified equity funds lost 26.57% for the first nine months, 16.26% over the last year, 8.41% for the last three years and 2.27% for the last five years. For the last decade, Smith says, an often-heard myth is that socially conscious investors are going to make less money compared with conventional investors. "It's a nonsensical argument. [The] managers pick and choose, but nonetheless it's almost treated like a religious mantra among conventional investors. We have stated again and again that there is no conscience penalty," he says. Adam Kanzer, general counsel and director of shareholder advocacy for Domini Social Investments, based in New York, agrees. "First of all, there's kind of a misconception that socially responsible investing has nothing to do with any standard kind of due diligence that a manager would undertake, that it only looks at social issues. That's not true," he says. "For actively managed SRI funds, their investment managers go through the same financial analysis any manager would use, but they also do social and environmental analysis." And SRI managers are the first to note that social and environmental issues can have a financial impact. "The SRI industry believes social and environmental performance does impact the bottom line. Most of these issues are long-term performance issues, but we're long-term investors," Kanzer says. How a company manages its labor force, including how diverse it is and how a firm treats the environment, can help it avoid regulatory fines and prevent lawsuits, he adds. Such practices lead to all sorts of efficiencies. Socially conscious screens also help identify management teams that are on the ball, ones that can handle many complex issues and come up with effective ways of dealing with them, he says. Many socially conscious fund managers were considering corporate governance in their investment decisions before the recent wave of corporate scandals. Socially conscious funds have been considering board independence, executive compensation and other issues for years in choosing investments, although many did not have specific screens for them. In the last couple of years, more socially conscious fund managers have started voting against independent auditors whose compensation for non-audit work exceeded various benchmarks. At Pax World Funds, for example, Green says, early in 2001 the firm began voting against them if 75% or more of compensation came from non-audit activities. "We found in that first year, we voted against auditors 37% of the time. And by the end of the year, we all heard about Enron (Corp.)" This year, Pax World instituted tougher standards and lowered its benchmark to 25%. Green didn't have figures available yet on how the change affected the number of votes against auditors. Concerns about corporate governance and social issues did help these funds stay away from companies that later became scandal-ridden. But it didn't help them avoid all the bad apples. With so much fraud and mismanagement surfacing, some managers have beefed up or added screens to identify potential management and financial problems. And many have been vocal supporters of regulatory changes that would require more openness and transparency in financial reporting. Joan Bavaria, president of Boston-based Trillium Asset Management, an independent socially conscious investment manager, says the firm avoided many companies plagued with serious problems, such as WorldCom, primarily because of social concerns. "The only one we got hit with was Enron, but we weren't hit as badly as others. Most of us depend on a system that's honest. No one can anticipate theft," she says. Other socially conscioius managers agree that corporate fraud and theft is difficult, if not impossible, to detect. Some of the worst offenders ended up in their portfolios until problems were revealed. For example, the Domini Social Equity Fund included Enron. Green says the Pax World High-Yield Fund owned some Adelphia Communications Corp. investments. Julie Gorte, director of social research at the Bethesda, Md.-based Calvert Group Ltd., says the firm's various screens helped its passively managed social index avoid about half the problem companies-including Qwest Communications International Inc., Tyco International Ltd. and WorldCom. But others made it into the fund, including Enron, Global Crossing Ltd. and Adelphia. Calvert, the category giant with 29 funds and about $8.5 billion under management, had already considered corporate governance issues when reviewing investments. But because of the magnitude of problems that have surfaced recently, it did a review and in August announced it was adding a new set of corporate governance and business ethics guidelines to its criteria. Among the 51 corporate governance issues Calvert now looks at are board diversity, compensation, securities fraud and the quality and independence of auditors. Gorte notes the company is using Corporate Governance Quotient (CGQ) ratings, introduced in June by Institutional Shareholder Services of Rockville, Md. CGQ ratings are supposed to help institutional investors evaluate the quality of corporate boards and the impact their governance practices have on company performance. "We have sharpened our filters, but whether it will add financial value in the long run, it's too soon to tell," Gorte says. Meanwhile, socially conscious managers also have been vocal supporters of regulatory changes that would require more openness and transparency in company reporting on financial and other issues. This community, which includes the Social Investment Forum, applauded the Securities & Exchange Commission proposal in September to require mutual funds and other registered management investment companies to disclose their proxy-voting record and policies. The SEC is now collecting comments on the proposal. "I think this is something we've been calling for for a long time and will make a significant impact on corporate governance and corporate accounting in general," Kanzer says. In fact, many socially conscious funds, including Domini, already have been posting their proxy-voting records at their Web sites. "Many securities are being voted in the dark and are being voted for shareholders by fund managers," Kanzer notes. "This will allow individual investors to monitor funds based on voting performance and will identify conflicts of interest-what funds are voting for when they are vying for 401(k) business, for example." Gorte says she also was encouraged by a recent proposal from SEC Chairman Harvey Pitt to eliminate an exemption that allows companies to challenge shareholder resolutions and keep them off their ballots. Many managers also have cheered the positive reforms in the Sarbanes-Oxley Act of 2002, signed into law by President Bush in July. The law enacted provisions to deter and punish corporate and accounting fraud. However, the social investing community doesn't think the law goes far enough in implementing safeguards to protect investors. Many managers and investors want actions taken that will enhance board independence and diversity, abolish staggered terms for directors, require expensing of stock options and increase disclosure on social and environmental issues. "There's much to commend in the reforms, but the reform train can't stop now," says Smith of the Social Investment Forum.