Socially Responsible Funds Buck the Outflow Trend in the US

This year, many dejected investors have thrown in the towel on their money-losing mutual funds, prompting billions of dollars in redemptions. But, surprisingly, socially responsible funds have resisted the trend.

Through the third quarter of 2001, funds that focus on socially responsible investing, or SRI, — those companies with strong environmental and labor records — have taken in more than a half-billion dollars of new money. In comparison, large-cap blend funds saw outflows of $13.5 billion. SRI funds had only two months of net outflows during the first nine months of the year, while general equity funds saw five months.

The flow of money continues despite the fact that some leading funds are performing worse than the S&P 500, due to their relatively large tech stakes.

"Socially responsible investors are not as short-term-return driven" as general equity investors, explains Don Cassidy, senior research analyst at Lipper. " [As a result, money inflows] aren’t quite as sensitive to the market’s ups and downs."

Investments in SRI Equity Funds Have Jumped in the Last 5 Years:

Year Net Fund Inflows
1996 $80 million
1997 525 million
1998 620 milllion
1999 1.32 billion
2000 1.18 billion
2001 (through third quarter) 575 million
Source: Lipper.

Stuck on Tech
Leading SRI funds often are overweight technology companies because they score well on environmental and labor screens. The funds refuse to invest in defensive value names such as tobacco, energy and industrial companies that fail to pass their screens. Fund screeners at Domini, for example, have said they won’t relax their guidelines to allow more value stocks in to diversify portfolios, notes Catherine Hickey, an analyst at Morningstar.

During the late 1990s, SRI funds benefited from their exposure to tech stocks. By mid-2000, SRI funds overall were twice as likely to claim Morningstar’s coveted five-star rating as other funds.

When the market shifted in 2000 and value came into play, SRI funds suffered. But the fund managers still haven’t changed their investing style and continue to avoid value-oriented stocks.

Consider $383 million Citizens Core Growth, one of the most tech-hungry SRI funds. By mid-2000, its weighting in the sector had surged to over 47%.

Though it labeled itself an index fund, it finished down 20.8% last year, trailing the S&P by 11.7%.

At the end of the second quarter this year, the fund still had more tech exposure than the S&P, and its returns continue to trail the index, with a year-to-date loss of 24.9% through Oct. 1, compared with the S&P’s loss of 18.8%. In an effort to stem further losses, fund representatives have said they plan to shift sector weights so that they more closely resemble the index, according to Morningstar.

Domini Social Equity, another leading SRI fund with $1.1 billion in assets, had a tech weighting of 38% in 1999. When growth stocks decreased, Domini’s returns took a hit. In 2000, the fund underperformed the S&P 500 by 6%, losing 15.1%.

At the end of the third quarter this year, Domini still had a heavy exposure to the tech sector, with a stake of 21.04%, compared with the S&P’s 15.3%. But the reduction probably reflects depreciation rather than any shift in holdings, according to Morningstar’s Hickey.

Even though most mainstream SRI funds underperformed the S&P 500 during 2000, some of the funds’ biggest holdings have fared better so far this year. "Microsoft is having a really good year, and it’s a big position for a lot of these funds," points out Hickey. "Some of the IBMs of the world are actually doing OK. Although Cisco and Oracle and those kinds of stocks aren’t helping [the funds’ performance] ."

To be sure, many niche SRI offerings have little in common with larger, growth-oriented funds — least of all a tech fixation. Such funds cater to conservative Christians, Muslims, feminists and avid environmentalists, among other constituencies.

For example, the New Alternatives fund, a $47 million small-blend offering, focuses on renewable energy, fuel cells and energy conservation. The fund posted a 51.8% return in 2000 (though it was down 16.7% through Oct. 1 this year). Most of its assets are in utilities, while only 12% are in tech.

Buyer Beware
The bottom line is that investors in SRI funds need to prepare for a slightly bumpier ride than the one offered by most plain-vanilla equity funds that own industrial and energy stocks. To compensate, investors might want to include more value-oriented stocks in their portfolios.

In addition to the funds’ stock-picking constraints, another potential downside to SRI funds are relatively high operating expenses due to the extra research involved in screening. Managers also tend to become involved in shareholder activism, spending money to send shareholders information about where companies stand on social issues and presenting various resolutions to corporate boards.

For example, Citizens Core Growth charges operating expenses of 1.49% of assets, while Domini charges 0.96%. By comparison, expenses on the ultra-cheap Vanguard 500 Index equal only 0.18%.

A couple of new offerings, however, offer better deals. Social Choice Equity costs only 0.27%, while Vanguard’s Calvert Social Index costs 0.25%.

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