If the words "socially responsible investing" still conjure up images of ageing hippies trying to diversify the commune’s pooled assets beyond the soybean farm, it is time to open your mind a little.
During the past 10 years, SRI – using ethical principles to invest – has evolved from being an oxymoron into a substantial force in global investing. The amount of money invested globally in socially responsible investments now totals almost Dollars 2,000bn, according to the Social Investment Forum.
Meanwhile, a study by Mercer Investing Consulting of 190 investment companies found
73 per cent of asset managers predicted that incorporation of social and/or environmental corporate performance indicators would become mainstream in 10 years.
Should investors consider incorporating SRI funds or strategies into their portfolio? I would answer an unqualified yes, because I generally believe that doing right by customers, shareholders, employees and the world at large translates into better returns over the long haul. Conversely, doing substantial harm to any or all of these catches up with a company. But I have many qualifications about the world of SRI. funds, which investors need to keep in mind before deciding to "do the right thing" when investing.
But I have many qualifications about the world of SRI. First, it is important to recognise the subjective nature of "ethical" investing. Are your ethics defined as religious, liberal, environmental, conservative or otherwise? Most big companies in the US can be seen as ethical or unethical depending on the vantage point. Pharmaceutical companies develop life-saving medicines but their practices have led to rocketing health costs and an overmedicated America.
Few companies perfectly fit the bill of "ethical" companies. Starbucks gets plaudits for treating its workers generously and the environment sensitively but one SRI fund sold its shares because the coffee shop chain recently lent its name to an alcoholic drink from Jim Beam. My ethical dilemma is that Starbucks has introduced coffee, a rather unhealthy product, to kids who have enough health and diet issues already. Make sure you understand your definition of SRI and find a fund that suits your needs.
Second, there simply are not enough outstanding SRI funds, especially when it comes to overseas investing. While some funds that pass muster on SRI screens are among my favourite offerings, I don’t think it is possible to build a diversified global portfolio based solely on SRI funds.
My third and biggest problem is that many socially responsible investments, when given the choice, put good works ahead of good returns. While a laudable notion, it runs counter to the primary function of a mutual fund or other investment vehicle: to make market-beating returns for holders. This sensibility runs counter to my belief that ethical investing should be more lucrative.
The best way to gauge SRI funds is by returns. With that in mind, let’s take a look at the best offerings.
Hedge funds: A small but growing number of hedge funds are billing themselves as SRI hedge funds.
"What differentiates us is that we use SRI as an alpha generator," says Jane Siebels of Green Cay Asset Management, a Palm Beach, Florida, firm with SRI offerings in emerging markets, hard assets and others.
Ms Siebels, who worked with Sir John Templeton, founder of Templeton Growth Fund and Templeton World Fund, says SRI is especially handy when deciding which stocks to sell short. Ms Siebels commissions business ethics professors to assist the search for ethics-light companies.
"We have found it much more effective to short stocks with bad values and then notify them that we are shorting them based on these values. Some have said ‘so what’ but others have changed because of us."
Green Cay’s impressive roster of values-challenged shorts includes Enron, WorldCom and Tyco – and Shell, based on concerns about its reserve accounting just before the scandal blew up. Best of all, Green Cay’s returns beat the markets over the long haul with less volatility.
Mutual Funds: There is a fairly big number of SRI mutual funds but I can count the best funds – the ones worth your money – on my hand.
The best large-cap is the Parnassas Equity Income fund, run by Todd Ahlsten. He recognises that no company is perfect but he does a good job at picking solid, upstanding companies such as Wells Fargo that also notch up impressive returns. The numbers are amazing: five-year average annual returns of 4.58 per cent and 10-year average annual returns of 11.7 rank Parnassas in the top 8 per cent of all large-cap blend funds, according to Morningstar. The fund also loads up on dividend-paying stocks, which helps it outperform in down markets.
I have been a huge fan of the Ariel Funds shop in Chicago for years but for a long time didn’t know that John Rogers’ value-oriented funds also passed muster on SRI screens. That is great news for value and values-oriented investors because it is among the best small-cap funds around – and the mid-cap Ariel Appreciation fund is equally impressive. The funds’ respective 10-year average annual performance – 15.6 per cent for the small-cap fund and 15.1 per cent for the mid-cap fund – rank in the top fifth of their peers.
For ethically minded investors who are also partial to index investing, the Domini Social Equity index fund is a solid choice. Based on the Domini 400 Social index, which tracks 400 companies that pass screens for environmental and social issues, the fund slightly trails the S&P 500. But that makes its performance better than most: its 10-year average annual return of 10 per cent beats 60 per cent of all large-cap blend funds.
Stocks: In some respects, the best way for SRI-minded individuals to ensure their ethics turn up in their portfolio is to buy the stocks themselves. There are a few stocks that pass my personal ethics screen and many that don’t make the grade. But everyone’s personal list will look a little different – for me to force my list on you doesn’t seem, well, ethical.