Finding an Audience
Whether these funds become popular will depend largely on how well they perform. Most of them have short track records, even if studies suggest that the companies in their universe are superior in many ways. Management consulting firm A.T. Kearney conducted the most recent study, examining 99 of the largest companies from two sustainable investment indexes, and found that companies in 16 out of 18 industries outperformed the market averages by 15% over the grueling six months from May through November of 2008.
The report concludes, "Most sustainability-focused companies may well emerge from the current crisis stronger than ever."

But the evidence from this and other studies is by no means conclusive, and sustainable investing has been the subject of some controversy and confusion. In their book Business Ethics, published by Oxford University Press, professors Andrew Crane and Dirk Matten note that the data used to determine whether a company is accepted into the Dow Jones series of sustainable indexes is based largely on questionnaires, submitted documentation, public reports and other information provided by the company itself. Although the data is analyzed by an outside consulting firm and verified by an independent auditor, "the assessment is basically an inside-out provision of data," they conclude. Keefe argues that sustainability analysts have access to the same information as other kinds of analysts, and have no particular advantage or disadvantage when it comes to obtaining information from companies, either from public sources or firsthand research.

Still, the occasional appearance of notable corporate transgressors in sustainability indexes shows that no research methodology is foolproof. In September 2007, less than two years before its colossal implosion, American International Group appeared in the Dow Jones North American sustainability index (it has since been removed), and even in late January 2008, a leading global research firm was naming AIG as one of the 100 most sustainable companies in the world. Troubled mortgage giant Freddie Mac, meanwhile, boasted a listing in KLD's Global Sustainability Index and was removed only in September 2008 after the U.S government was forced to rescue it. Bailout recipient Washington Mutual got booted from the index the same month.

There is also some confusion about exactly what "sustainable" means, and no standard industry definition. DFA's sustainability portfolios focus on environmental impact considerations, yet the firm's fact sheets make no mention of governance practices or social criteria. By contrast, the FTSE KLD, Dow Jones and FTSE4Good indexes have much broader mandates. Some of the indexes apply financial screens, while others only look at sustainability characteristics and leave it to the product sponsors to apply financial and valuation criteria.

Others point out that traditional "sin" companies like tobacco companies and defense contractors are fair game for these indexes, too. The DJSI World Index, for example, includes tobacco maker British American Tobacco and spirits maker Heineken. (Dow Jones has separate sustainability indexes screening just for social concerns, though these aren't yet used in any U.S. products.) Still, DFA's sustainability portfolios list Wal-Mart among its top-ten holdings, a company long criticized for spurning unions and selling goods produced by cheap overseas labor.

Sustainable investing also often includes "clean and green" index portfolios such as the popular PowerShares WilderHill Clean Energy Portfolio (PBW), the PowerShares Cleantech ETF (PZD) and the First Trust NASDAQ Clean Edge Green (QCLN). With the increasing focus on alternative energy and global warming, the number of environmental indexes and products based on them has grown in the last couple of years. But because they often focus on smaller companies and are in a single sector, these funds and ETFs are typically more volatile than a broader sustainable investment portfolio.

Just as the definition of sustainability investing seems to be a moving target, the line between this discipline and what might otherwise be considered simple, old-fashioned investigative fundamental analysis can become blurred as well. Investment managers of all stripes would likely avoid companies with bad environmental track records just because of the litigation concerns. Or they might otherwise likely analyze the sustainability of earnings and look for financial smoke screens, scrutinizing executive compensation or board voting records. What some might call sustainability analysis others might just label a comprehensive financial checkup.

Thomas Kuh, managing director at KLD Analytics, acknowledges that sometimes people in his field cross over with traditionalists, but says "our analysts have greater sensitivity to sustainability criteria and a more systematic and comprehensive approach to finding companies with sustainable characteristics." He adds that while a company-by-company evaluation of components in his firm's indexes might reveal a few bad apples, "the companies in our indexes, as a whole, have a higher level of sustainable qualities than those in the broader indexes."

Keefe also acknowledges the crossover, but says mainstream analysts typically do not apply the same rigorous and systematic ESG criteria that specialists do. "Over time, a portfolio of sustainable companies has distinct advantages over a portfolio of companies without those characteristics. Positive ESG practices show that a company is forward-thinking and preparing well for the future."

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