has a long tradition of socially responsible investing. The San Francisco-based mutual-fund firm favors companies that not only respect the environment but also support local communities where they do business. It won't touch outfits that profit from tobacco or manufacture weapons, and passes on uniform maker Cintas because its laundries throw off wastewater containing chemicals. So what's one of its top holdings these days? An oil and gas giant, Apache. Parnassus says the $8.3 billion company deserves credit for things like starting schools for young girls in Egypt and offering profit sharing and stock options to lower-level employees. The reasoning, though, doesn't quite fly with other socially conscious fund companies. Indeed, Calvert, the largest, argues that Apache fails when it comes to respecting the rights of local populations.
Confused? Join the crowd. With everyone from Al Gore to General Electric on the bandwagon to save the earth, the idea of doing good while making money is spreading to all corners of the financial world. Just ask John Edwards, who ran into withering criticism this past summer for his investment in a company linked to foreclosures on Katrina-ravaged homes. (He promptly pledged to purge the investment from his portfolio, saying he didn't fully understand its complex operations.) Even Goldman Sachs is getting into the act, creating a team of analysts who research and rate companies based on their environmental, social and governance policies.
Nowhere is the idea hotter or more perplexing than in the world of socially responsible mutual funds. Once favored by a minority of do-gooders, they're increasingly popular on Main Street. In the past 10 years, assets in socially responsible mutual funds have ballooned, to $50 billion from $8 billion, as the number of funds has doubled, to more than 100. Even employer retirement plans, long known for their offerings of standard stock and bond funds, are climbing aboard as many as 60% of plans expect to have some socially responsible investing options by 2010, according to a recent survey by Mercer Investment Consulting.
But all the growth has brought more than a little confusion, as some funds that call themselves socially responsible take opposing views on the same stock and others adjust some say water down their criteria for what exactly qualifies as socially responsible. "You get 10 socially responsible investors in a room, and you'll get 10 different opinions of what the definition is," says Todd Ahlsten, a portfolio manager at Parnassus. To critics the proliferation of socially responsible funds is resulting in a hopeless muddle, with the largest and oldest of them loosening their investing requirements in the competition for new customers. "They weaken their standards so those standards don't cause an obstacle to growth," says Paul Hawken, founder of garden retailer Smith & Hawken and head of the Natural Capital Institute, which conducts research on socially responsible investing, among other topics.
Then there's the matter of making money. With giant multinationals like BP and GE saying there are profits to be made in going green, it's getting harder for socially responsible funds to get away with posting meager returns. We found four funds with different definitions of "socially responsible" but with one thing in common: strong returns.
Winslow Green Growth (
When it comes to being green, it's tough to have more street cred than Jackson Robinson. The manager of the Winslow Green Growth fund was raised in a self-sufficient household in the 1950s after his parents sold their Manhattan digs to move to rural Connecticut Green Acres-style. They even wrote a guide for future homesteaders, "The Have-More Plan," which is still in print half a century later. Like his folks, Robinson, 65, is a trailblazer. Everybody is going green now, but he has been investing that way since 1983. Winslow Green Growth has an average annual return of 27% in the past five years putting it among the top-performing funds in the small-cap-growth category, according to Morningstar.
Robinson's career as a green investor began in the late 1970s, when he was the chief financial officer of the garden-supply company GardenWay. He noticed that the most profitable product in the lineup was a tiller made with recycled materials. The Brown University graduate, who had previously worked at Prudential Securities, devoted himself to exploring what he saw as a link between environmental responsibility and financial performance. Soon after, he formed the investment advisory that runs the mutual fund.
Along with comanager Matthew Patsky, a former Lehman Brothers stock analyst, Robinson looks for companies with a market value of $50 million to $2 billion that meet the fund's standards as clean or green. In other words, firms that are managing their impact on the environment, such as an energy-efficient tech firm, and those trying to solve environmental problems, like a maker of wind turbines. Robinson is the first to admit that you can't paint alternative energy with a broad stroke; as with any developing field, some technologies won't pan out. That's why he seeks companies with an annual growth rate of at least 20% and little or no debt. Two firms Robinson likes now are EnerNOC and Comverge, which make products and offer services that let utilities cut the use of their oldest, least-efficient and highest-polluting generators.
While the fund's exposure to small, speculative stocks has driven the stellar performance, it also makes for volatility. It dropped 38% in 2002, underperforming most of its peers, only to nearly double the following year. The swings have led to some wild asset gyrations over the years. Now, with green fever running high and alternative-energy companies rallying in the stock market, some $100 million in new money has come into the fund recently, bringing assets to over $300 million. Robinson has pledged to close to new investors at $500 million, which bodes well for his ability to stick to the strategy in the future.
Pax World Balanced (
Christopher Brown, manager of the Pax World Balanced fund, grew up with socially responsible investing. His father, Anthony Brown, helped start Pax in the early 1970s and stayed with it until retiring in 1998, when he turned the job of managing the balanced fund over to his son. Even so, the 73-year-old Anthony Brown is still in the business of giving friendly advice, including expressing some qualms when the fund ended its three-decade ban on all "sin" stocks last year.
"I'm old-fashioned," says Anthony Brown. "The world is changing," his son replies. While the fund still shuns most stocks that profit from weapons, gambling, tobacco and alcohol, it no longer has a zero-tolerance policy on alcohol and gambling. Critics say that's giving up too much to boost returns, but proponents say socially responsible funds are now considering both positive and negative factors and picking stocks that get high marks. Most new investors in this field invest because they "care about the environment and social policies, not because they are against alcohol," says Joe Keefe, Pax World's chief executive.
Beyond the social research, Brown looks for industries around the world that are growing at a higher rate than the overall economy and stocks trading at what he figures are reasonable prices. As a balanced fund, Pax can hold up to 75% of assets in stocks. These days Brown sees more opportunities outside the U.S. because he believes that global economic growth will outpace domestic growth. In the U.S. he likes technology companies like Cisco Systems, which get a big chunk of their revenue from overseas. Brown typically keeps the bond investments conservative, with high-quality, short-maturity government-agency bonds and highly rated corporate bonds. "The bond portion is a shock absorber," he says. Some investors avoid balanced funds, preferring to choose their favorite stock and bond funds themselves. But for those looking for a broad SR mandate and willing to turn the allocating over to Brown, Pax Balanced is a good choice. In the past 10 years, the fund has beaten 92% of its peers, with an average annual return of 8.6%, according to Morningstar.
How's this for practicing what you preach? Headquartered with environmental groups in the Natural Capital Center in Portland, Ore., Portfolio 21 has been carbon-neutral since 2001. For company Chairman Carsten Henningsen, who entered the business by starting an investment company out of his house in 1982, that means reimbursing employees for the cost of public transportation and even the maintenance of bicycles they ride to work. Portfolio 21 goes so far as to calculate the carbon dioxide emissions associated with its business travel and purchases carbon offsets to make up for it.
The fund says it's just as fastidious when it comes to picking stocks. Companies have to satisfy a complex scoring matrix that shows they're making an active commitment to protecting the environment. Japanese textile manufacturer Teijin Ltd. had been in Portfolio 21's research pipeline for more than a year before portfolio managers bought the stock. On the plus side, they liked the fact that Teijin had developed a process for recycling polyester and put it to work in a partnership with outdoor clothing maker Patagonia. Teijin also produces polycarbonate resin and carbon fiber, which could enhance energy efficiency in automobiles and trains. On the downside, they saw that Teijin is involved with "dirty" products, like making plastic for bottles. "We wanted to understand where the company was really focused," says Anthony Tursich, one of the portfolio managers. So he burned up some carbon and traveled to Tokyo to grill Teijin management in person. Satisfied, Portfolio 21 now has 1% of the fund in Teijin shares.
The exhaustive stock-picking analysis draws heavily on something known as the Natural Step a sort of Six Sigma for preserving the environment that's based on the laws of thermodynamics. That means keeping an eye out for things like Teijin's recycled fleece. Portfolio 21 also calculates "an environmental risk premium" based on a company's exposure to certain factors, like the scarcity of natural resources and climate change.
Portfolio 21 lays out the rationale for its stock picks in excruciating detail on its Web site: Intel, for example, wins praise for seeing "a direct relationship between its competitiveness and the energy efficiency of its products," while Toshiba got the boot last year for an acquisition that gave it too much exposure to the nuclear-power industry. In an industry that has been criticized for being confusing and unclear about what qualifies as socially responsible, Portfolio 21 gets a gold star for transparency. With more than 100 holdings, it's also diversified, which should mitigate volatility. The fund is beating most of its peers and the MSCI World index in the past one-, three- and five-year periods, although it's not at the top of its category. It also isn't cheap. Portfolio 21 charges investors 1.5% a year that's $150 on a $10,000 investment compared with a median of 1.23% among world stock funds tracked by Morningstar.
Neuberger Berman Socially Responsive (
Long before Arthur Moretti started picking stocks for one of the leading socially conscious mutual funds, he had his eye on Newfield Exploration. The Houston-based oil and natural gas driller was doing something unique with its financial statements: including the cost of restoring drill sites to their original state. Never mind protecting the environment. Moretti, a Princeton-trained economist, simply liked the bookkeeping. "That's just conservative accounting," says Moretti, who coheads the Neuberger Berman Socially Responsive Investor fund, which has a stake in Newfield.
Today the energy company illustrates the strategy of the Neuberger fund, which pairs Moretti's Wall Street background with Ingrid Dyott's experience as a researcher. Dyott got her start at the Council on Economic Priorities, which rates companies based on their social and environmental records. Moretti admits that the conscience penalty the idea that investors need to give up some return if they mix money and morals was one of his concerns when he joined the Neuberger Berman fund in 2001. Complete strangers at the time, Moretti and Dyott found that their portfolios were surprisingly similar. "It's not just a coincidence," says Dyott.
They might be right. The fund has outpaced the Standard & Poor's 500 by more than two percentage points a year in the past five years and has beaten 90% of its peers in Morningstar's large-blend-fund category. The managers concentrate assets in their best ideas, which means that returns can be volatile in the short run. Like most socially responsible funds, the fund has "avoidance screens." It doesn't invest in companies that profit substantially from tobacco, gambling, alcohol, weapons or nuclear power, but it takes a best-in-class approach to energy and materials companies.
That's why Newfield, one of 41 stocks in the fund, passes muster. The team views natural gas, which contributes the lion's share of Newfield's revenue, as a more environmentally friendly energy source than oil, coal and nuclear power. It also helped the fund get a piece of the action in the recent energy rally. Newfield shares have more than tripled in the past five years. This strategy ruffles the feathers of some purists, but the Neuberger Berman managers stand by their mandate. "It's not the best house on the worst street," Dyott says. "We are looking for good companies."
Old Players, New Game
It's a new game for the old guard. Not long ago pioneers like Domini Social Investments, Calvert and Pax had the world of socially responsible investing pretty much to themselves. Today, with increased competition and investors pushing for decent returns, they're searching for the right formula and getting some heat in the process.
After a strong 10-year run, the Domini Social Index fund trailed the broader market by an average of more than two percentage points a year over the past five years. Part of the problem was that as a socially responsible index fund, it screened out many stocks in hot sectors like energy, gambling and defense. It also levied a hefty annual expense ratio of 0.95% or $95 for every $10,000 invested in the fund well above the 0.58 median expense ratio for index funds. A year ago Domini threw in the towel, hiring Wellington Management, the Boston-based money manager, to actively manage the $1.1 billion fund once the SR screening is done. Wellington now employs a quantitative strategy for the fund, using computer models to pick stocks. Fund matriarch Amy Domini, who admits that she lost shareholders who were believers in the index strategy, figures it will take about three years of good returns before she's vindicated by the switch to active management. But she's off to a rough start: The renamed Domini Social Equity fund is trailing both its fund category and the S&P 500 by about four percentage points so far this year.
Domini's competitors took another approach. Pax World, with $2.7 billion in five funds, and Calvert, with $15 billion in assets, are shifting away from knee-jerk avoidance of "sin" stocks to hands-on human analysis of what qualifies as socially responsible. The funds say that changing their methodology allows them to respond to an increasingly complex world. It also may help them attract more money. But investors like James Tu, owner of the Zen Palate chain of vegetarian restaurants, are left scratching their heads. His suggestion? Create "some kind of certification" for what's socially responsible.