Broad acceptance follows solid performance by indexes and funds.
Every so often Peter Kinder, president and
co-founder of KLD Research & Analytics in Boston, gazes out his
window at Fort Point Channel and the Federal Reserve Bank with a sense
of accomplishment about the growth of socially responsible investing.
LD developed the Domini 400 Social Index about 15
years ago. The index, a benchmark for more than $10 billion in socially
responsible stocks, is made up of 400 companies that pass multiple
broad-based social and environmental screens. Investors in socially
responsible stocks typically are religious institutions, educational
institutions, pension funds and mutual funds.
Kinder and Amy Domini, his former wife, cooked up
the idea of a socially responsible investing index more than 20 years
ago on their kitchen table in Cambridge, Mass. In 1989, Domini, Kinder
and their partner, Steve Lydenberg, began work on the Domini 400 Social
Index, which was launched in 1990. Today, Kinder presides over the
research and consulting firm with 33 employees, including 18 analysts.
Meanwhile, Domini runs a stable of socially responsible index mutual
funds for Domini Social Investments in Boston.
"I feel like a different person," Kinder says. "It
seems inconceivable how far we have come since the 1980s. I was the
first employee in 1988, and did the research on the index until we
launched it in 1990."
In the mid-1980s, approximately $100 million was
invested in socially responsible stocks. Investors were driven by
antiapartheid and antitobacco sentiments. Today, there are 200 mutual
funds with assets of $150 billion that make up socially responsible
investments, according to the Social Investment Forum of Washington,
D.C. The $2 trillion market of socially responsible stocks is driven by
diverse social forces and religious concerns.
In recent years, KLD has launched indexes that can
be used to benchmark different investment styles. The indexes include
Social Select, Large Cap, Broad Market, Nasdaq and Catholic Values.
On the investment side, Barclay's Global Investors recently started an
exchange-traded fund, the KLD Select Social Index. Meanwhile Domini
Social Investments offers the Domini Social Equity Fund, Domini Social
Bond Fund and the Domini Money Market Account. The company has no ties
to KLD.
The Domini indexes, however, are not the only game
in town. International investors can use several "Dow Jones Suitability
Indexes" to benchmark their overseas investments. Nor is KLD the only
company providing social screens to institutional investors. An
estimated 25 companies screen for socially responsible investments
worldwide.
Joshua Humphreys, research coordinator for the
Social Investment Forum, says the Calvert Group and Citizens Funds
started socially responsible stock indexes a few years ago.
Calvert, in Bethesda, Md., uses the Calvert Social
Index in-house. It includes 620 to 650 stocks, based on seven social
screens as well as value and growth criteria, gleaned from the Russell
1000 stock index, according to Steve Falci, Calvert Group chief
investment officer. Citizens Funds, of Portsmouth, N.H., also uses its
own index.
By contrast, the Domini Social 400 screens the
inappropriate stocks out of the S&P 500, then seeks additional
socially responsible stocks from the Russell 1000. "The Domini Social
400 is the oldest and most prevalent socially responsible index,"
Humphreys said. "The indexes are all quite comparable and highly
correlated."
Not all mutual funds use the Domini index as a
benchmark. Anita Green, vice president of social research with the Pax
World Fund Group in Portsmouth, N.H., said her fund group uses the
Lipper averages as benchmarks. The reason: The company would rather
compare its funds to the universe of funds, and not limit it to
socially responsible investments. Pax World has balanced, growth,
high-yield and money funds.
"There is nothing wrong with the Domini 400 Social
Index," she says. "The Pax World Fund is the oldest (socially
responsible) fund. We have always used the Lipper benchmarks."
Socially responsible funds formerly avoided "sin"
stocks-companies in the gaming, liquor and arms businesses-and
companies that did not pollute the environment. But Green says many
socially responsible mutual funds now go one step beyond the
traditional screens. For example, the Pax World Fund only invests in
companies that favor women and minorities. Since its inception in 1971,
the balanced fund has grown at a 9.5% annual rate.
The fund owns stocks such as: Amdocs, an Israeli
company that makes support software for back-office telecommunications;
PepsiCo, which has a number of women and minorities on its board of
directors; and Johnson & Johnson, which offers diversity as well as
good employee benefits. On the bond side, it favors Jafra Cosmetics
bonds because the company is run by women.
Falci, of Calvert Group, says community investment
is one of the fast growing areas of socially responsible investing.
Calvert wants to invest in companies that promote communities, small
business and housing and international economic development.
Many investors scoffed at the idea of socially
responsible investing 15 years ago. Not now. Today, Kinder says pension
funds, other institutional investors and individuals are concerned
about corporate governance policies and global warming.
Over the past 15 years, the Domini 400 Social Index
has outperformed the S&P 500, according to Dow Jones and Standard
& Poor's. The Index has gained 439% since its inception on May 1,
1990. By contrast, the S&P 500 grew 382%.
The Domini 400 Social Index, however, has lagged
over the past three-year and five-year periods. Reasons: Declining
technology stock prices and rising energy stock prices hurt social
stock returns.
Kinder says that in the longer term, the index has
stood up well versus the broad market. Socially responsible companies,
he says, tend to have good management and employee relations, which
typically help financial performance. But he stresses that performance
should not be the only criterion for ethical investors.
Financial research shows that Kinder may be on the
right track. A 2005 study by James Ang, a finance professor at Florida
State University, found that better managerial skills result in good
stock price performance. The study was published by the Financial
Management Association.
Earlier research, in 2003, found that companies with
poor governance policies also had lower stock values. That research, by
Gompers, Ishii and Metrick, appeared in the article "Corporate
Governance and Equity Prices," published in the Quarterly Journal of
Economics.
However, socially responsible stocks are not without
critics. Emily Hall, an analyst with Morningstar Inc. in Chicago, found
that socially responsible funds as a group performed as well as funds
that do not screen for social responsibility. Individually, socially
responsible fund performance varied dramatically. "As a group they are
about average," Hall said in a 2004 report.
Hall's greatest concern: There are not enough
socially responsible funds to build a diversified portfolio. Falci, of
the Calvert Group, disagrees. Calvert offers 14 different types of
mutual funds, including an international fund, bond fund and money
fund. The funds are managed by subadvisors. Many of its funds have
outperformed their respectable markets over the past three years,
powered by stocks like Apple Computer, Erog Resources, Nordstrom,
Western Wireless and Marvell Technology.
Last April, Calvert launched two funds of funds, a
conservative asset allocation fund and a moderate asset allocation
fund. "The markets are deep enough today for asset allocation," Falci
said. "Both the number of (socially responsible) stock and bond issues
are poised to increase, particularly with the focus by investors and
corporations on corporate governance today."
Other critics believe that the socially responsible
mutual funds are too liberal with their screening. A 2005 study by
environmental stock advocate Paul Hawkin found that socially
responsible funds may not be so responsible when it comes to picking
stocks. The study published by the Natural Capital Institute
(www.naturalcapital.com), a Sausalito, Calif.-based environmental
research firm, found that the top 30 holdings of socially responsible
stock funds are almost identical to those of the Dow Jones Industrial
Average. And 90% of Fortune 500 companies are included in socially
responsible mutual fund portfolios.
The study claims that socially responsible mutual
funds own socially irresponsible companies, including: American
International Group, Coca-Cola, Wal-Mart, Clear Channel, Altria,
Halliburton, McDonald's, Raytheon, Exxon Mobil, Monsanto, Dow Chemical
and General Electric.
Green, of Pax World, disagrees. She says the
criteria used to screen for socially responsible stocks differs from
fund to fund. By lumping all funds together, Hawkins' data may be
distorted because of a few large funds with limited social screens.
Some funds may just avoid one industry, such as liquor or arms. Others
invest based on various degrees of socially responsibility.
"If there is a perfect company, I haven't seen one,"
she says. "It is a matter of degrees in screening stocks. After that,
it is more art than science."
Alan Lavine is the author of numerous books and a contributing editor to Financial Advisor.