The common knock against socially responsible investing (SRI) is that it's good for the conscience but not so good for one's portfolio. Critics say it puts investors at a disadvantage to exclude certain sectors such as tobacco, booze and gambling (the so-called sin stocks), or any other businesses with questionable environmental, social or governance records. Taking these companies out of the game limits investment choices, they contend.
But the data suggests that SRI isn't necessarily the portfolio killjoy its detractors say it is. It has its ups and downs like any other approach, but in many cases it generates comparable returns with other investment types. And its proponents say that societal and corporate trends will boost the SRI cause thanks to growing interest in green investing and calls for improved corporate accountability and disclosure in the wake of the recent Wall Street meltdown. "We never claimed you'll make more money investing in a socially responsible manner," says Steve Schueth, president of First Affirmative Financial Network, a network of advisors specializing in sustainable investing. But they can do just as well, he says, "and they might do better or worse at times. So why not put money to work in a way that helps society along the way?"
According to the most recent report from the Social Investment Forum, the total assets under management in SRI strategies leaped 324% between 1995 and 2007, to $2.71 trillion. During that time, the broader universe of assets under management jumped only 260%. All told, SRI-related assets represented 11% of total assets under management in 2007.
There were 260 socially screened mutual funds in 2007, up from 55 in 1995. The Social Investment Forum reports that socially screened, separately managed accounts for institutional and high-net-worth investors made up the vast majority of SRI assets.
ROI On SRI
But what are people getting for their SRI money? It depends on how you look at it and the time frame you're looking at. Seven of the ten domestic SRI indexes developed and tracked by KLD Research & Analytics topped their respective Standard & Poor's benchmark indexes this year through the end of the third quarter. Same goes for five of KLD's seven global indexes (granted, all but one of these 17 indexes were in the red by double-digit amounts).
The longer-term scorecard is sketchy because many of KLD's indexes are relatively new. The Domini 400 Social Index-the granddaddy of SRI indexes-was up 9.98% since its 1990 inception versus a 9.35% gain for the S&P 500. But most KLD indexes with three- and five-year track records have underperformed their respective S&P indexes, including the Domini 400.
SRI funds "tend to behave differently," says Morningstar fund analyst David Kathman. He and others who follow the space note that SRI screens usually favor newer, growth-oriented areas in sectors such as tech, companies that treat their employees well and aren't heavy polluters. Conversely, the screens generally eschew the likes of heavy industry, chemicals and oil. That worked fine during the tech bubble. But later, SRI funds missed out when commodities and old economy standbys did well in recent years.
"It's illustrative of how screens can result in different performance, and you have to understand what drives that performance," Kathman says.
Research from the likes of the United Nations and Goldman Sachs indicates that social investing can hold its own with the more conventional kind. A collaborative report published in October 2007 by the United Nations Environment Programme Finance Initiative and the Mercer consulting group reviewed 20 academic studies on the impact of environmental, social and governance (ESG) factors on portfolio performance. The result: Half of them found a positive relationship between ESG factors and investment returns, while seven studies found a neutral effect and three found a negative correlation.
In June 2007, Goldman Sachs launched its GS Sustain focus list of 96 companies in both mature and emerging industries around the world that satisfy Goldman's own list of ESG requirements. The roster includes the likes of Nestle, Johnson & Johnson and mining giant BHP Billiton, along with solar, wind and biotech companies. In a June 2008 report, Goldman said the list had outperformed the MSCI World Index by 20.8% since its launch. The report noted Goldman found "a positive relationship between ESG, industry positioning and return on capital over time" in each sector where it applied its GS Sustain criteria.
What's In A Name?
In a nutshell, SRI considers both investors' financial well-being and an investment's impact on society, which can range from how much it pollutes to whether it conducts business in Sudan. The approach has three components: community investing, shareholder advocacy and the screening of companies according to environmental, societal and corporate governance factors.
Many people now refer to the social investing space as ESG, rather than SRI. The difference is more than just semantics: ESG adherents believe their approach encourages more sustainable business practices and finds an improved way to evaluate investments. "We look at it as better fundamental analysis," says Joe Keefe, president and CEO of the social investing fund company Pax World Management. "In general, we believe ESG standards are a proxy for better management among more forward-thinking and opportunistic companies. These companies are doing a better job at managing risk."
Keefe says socially responsible investing emphasized the negative-i.e., screening sin stocks and other no-no companies according to certain social values. He adds that sustainable investing is a more positive and inclusive approach based on sound business practices. It's more about what you do invest in than what you don't.
In theory, companies with higher ESG standards will have more efficient manufacturing processes that pollute less. They would also focus on cutting-edge, 21st century products that make the world a better place, and they would treat their workers-and shareholders-better.
Calvert, an asset management company and long-standing player in the social investment universe, is adjusting its game plan to fit the new ESG mind-set. Calvert screens companies for their records in seven core areas: good governance and ethics; their creation of a benign workplace; their environmental sensitivity; product safety; human rights; indigenous peoples' rights; and community relations. Companies in its core funds must pass all seven screens.
"One of the tricky aspects is balancing between people who still want a values-based investment approach and those who want more sustainability that's more about finding value," says Paul Hilton, Calvert's director of advanced equities research.
One of Calvert's major new themes is creating mutual funds that are geared toward finding solutions to global problems, investing specifically, for instance, in alternative energy or water. (Companies in these more specific funds don't necessarily have to pass all seven of Calvert's screens.) "Just as companies are changing," Hilton says, "Calvert has to evolve so we can remain flexible."
Like other investing disciplines, SRI can be either active or passive. "Most SRI funds tend to track indexes fairly closely," says Kathman from Morningstar. "They tend to not be big risk takers."
But being tethered to the indexes was a problem in recent years for socially responsible investments when Big Oil, gambling stocks and defense companies were cashing in from higher crude prices, the booming Chinese gaming market and the Iraq War. "Those areas aren't easy to get into as an index fund," says Amy Domini, president of Domini Social Investments and one of the developers of the Domini 400 Social Index.
Consequently, Domini shelved its passive index-based investment approach in 2006 in favor of active management. The screening research for its funds is done in-house, and Wellington Management handles the quantitative asset management side. Unfortunately, the timing for the switch wasn't good. "In 2007, our quant models fell apart and we had a terrible year," Domini says. "It was related to model failure, not SRI failure."
But she believes the quant approach will allow her funds to be more nimble when the markets are dominated by story stocks. As of the third quarter, three of Domini Social Investments' five funds outperformed their benchmarks this year.
Patrick Geddes, chief investment officer at Aperio Group, builds custom portfolios with an SRI bent that are indexed to traditional benchmarks such as the S&P 500 or the Russell 3000 while incorporating research from the likes of social investing research firms KLD and IW Financial.
"Probably 20% to 25% of our clients have some sort of social screening," says Geddes, co-founder of the Sausalito, Calif.-based boutique investment firm. Their investments can range from something as simple as the Russell 3000 without tobacco, he says, to a Christian Science foundation that proscribes the usual sin stocks but also nixes health-care companies. "It's kind of a weird restriction in the world of investing," he says of the health-care exclusion, "but as an indexer, we can quantify how much that will cost in tracking error and then deliver it."
"The proposition," he adds, is to do SRI "in an intelligent way that tries to undercut the dismissal by most of the industry that it's a feel-good thing but a waste of time."
Craig Muska, managing director at IW Financial, says his company's research helps clients define ESG values according to their own perspective. For example, some folks might see nuclear power as a green energy solution while others consider it a pox upon humanity. "We're hearing more people ask us to help them understand their options for incorporating ESG in a way that'll meet their performance requirements," he says. "And we don't often have conversations with people who say they don't care about performance."
Blowin' In The Wind
Steve Schueth from First Affirmative Financial Network says Al Gore's movie An Inconvenient Truth perked up interest in SRI. He believes this space will have the wind at its back thanks to growth in such areas as green technologies, organic and natural foods, and alternative health care.
Amy Domini says the recent financial crisis could prompt legislation that improves the SRI landscape by requiring better corporate disclosure. "We're saying give us standardized disclosure across all companies in areas such as carbon footprint, waste disposal and risks to employees from the way they do business," she says. "We need to enrich the historical definition of investor well-being."
Going forward, Domini believes there will be various environmental incentives and more emphasis on management quality within the corporate sphere. "I feel we're ready for that new era and we'll be better positioned for it," she says.
If so, maybe more folks will consider socially responsible investing to be financially responsible investing, too.