Robert Schubert bikes> to work, shops at mom- and-pop stores and organizes a local farmers' market in Washington, D.C., all in a bid to reduce his impact on the environment. So after the BP oil spill, he checked his retirement fund to make sure it was investing in outfits that share his green values. The good news: no BP. The bad news: His mutual fund owned shares of oil driller Transocean and energy giants ConocoPhillips (COP)
Amid all the headlines about money fleeing stock funds, one category of funds has been doing just fine. The group known as socially responsible mutual funds pulled in more than $200 million in 2010, sending assets past $45 billion, as tough times led more people to search for ways to make their investments match their values. But behind the growth are a few surprises that are giving some investors pause: portfolios sprinkled with companies that don't fit their idea of socially responsible investing (or SRI), fund managers who seem more like bystanders than activist investors, and a sense that some funds just pay lip service to their ideals. A SmartMoney examination of the 20 largest non-faith-based, socially responsible equity mutual funds found that half owned oil companies a puzzling choice to investors concerned about the environment. According to the industry's Social Investment Forum, just 27 percent of socially responsible mutual funds actually agitate for changes at the companies they own, such as by filing shareholder resolutions over specific issues. "There is a lot of lazy SRI out there," says Cary Krosinsky, vice president at sustainability research and consulting firm Trucost.
There are also a lot more stocks finding their way into socially responsible investments these days. Indeed, with everyone from the $135 million Appleseed fund to big fund families like Legg Mason (LM)
Part of the problem is everyone has a different idea of what social responsibility means. Tobacco is out, but what about nuclear power? Is it responsible to own a polluter with the idea of encouraging it to go green, or is it best to avoid the company altogether? Some advocates of socially responsible funds say that while funds might have different answers to these questions, they need to be clear about their mission. And some funds point to long records of activism. Just two firms Calvert Investments and Walden Asset Management were responsible for more than a quarter of the shareholder resolutions filed by socially responsible funds on environmental and social issues in 2010.
In one recent victory, Domini, concerned by reports of slave labor in Brazil's pig-iron industry, says it used its investment in Nucor (NUE)
Indeed, the rapid expansion of these funds seems to have blunted an old criticism: that they can't keep pace with the market. Over the past five years, the KLD 400 Social index, widely used as a benchmark for the group, managed a 1.1 percent average yearly gain, slightly better than the 1 percent gain in the S&P 500. But the very diversification that appears to have helped performance makes the lines between the funds seem blurrier than ever. "SRI is never black and white," says George Gay, CEO of First Affirmative Network, which specializes in socially responsible investing. "There are trade-offs."
Blurring the Lines
Blurring the Lines
For years, managers of socially responsible funds stayed away from certain companies and industries a practice that made their portfolios look much different than other mutual funds. But with the number of funds calling themselves socially responsible more than doubling to 166 in the past 10 years, 475 of the companies in the S&P 500 now show up in one such fund or another. The overlap is seen in individual funds: For example, more than half the Pax World Growth fund mirrors Fidelity's Growth Company fund, according to Lipper. Julie Gorte, senior vice president of sustainable investing for Pax World, says all the focus on social responsibility has led companies to improve their behavior. She estimates that two-thirds of large-cap companies meet her firm's criteria, up from about half in the early days of socially responsible investing.
Industry experts say another reason for the similarity in portfolios is that big institutions like pensions are looking for socially responsible funds that are more diversified. That way, those institutions can pay more attention to environmental, social and governance issues but still satisfy their duty to protect clients' money. And that's led some funds to consider new holdings, even if it means owning shares of once-taboo businesses. Today some big oil and drug companies can be found in the $86 million Calvert Large-Cap Value fund, even though they don't pass the screens for Calvert's other funds. Calvert says that to stick with its social responsibility goals, it intends to push companies to change and sell the shares if it doesn't see enough progress. At the same time, Calvert executives acknowledge they haven't sold any stocks on social grounds since the fund's late 2008 launch. Bennett Freeman, Calvert's sustainability research and policy chief, says discussions with companies take time but that the fund's patience is limited. "We must see tangible progress, or we will divest," he says.
Then there's what might be called the good-apple method of stock picking: Go for the "best" company in an industry that otherwise might be avoided. Until they ran into trouble, both BP and American International Group (AIG)
The idea of investing according to your conscience is hardly new. In the 17th century, the Quakers avoided doing business with firms involved with weapons or slavery. Today socially responsible investing has branched out to include everything from a company's practices on diversity and the environment to its policies on animal testing and human rights. Other funds focus on women's issues and companies with good workplace environments.
What some investors don't realize is that many of these funds rely on outside research firms to steer them to their stock picks. The researchers dig through corporate documents, touch base with nonprofits specializing in issues like human rights and pore over media reports. But they can't always measure what investors might want them to measure. While some publicly traded companies are providing more information about issues like carbon emissions and workforce diversity, for example, others still offer no data at all. And investors who expect the researchers to play detective by, say, sneaking into Chinese factories or trekking into the rain forest to check up on mining companies are likely to be disappointed. "We cover more than 4,000 companies, so we don't have time to do in-depth site visits," says Laura Nishikawa, a senior analyst at MSCI ESG Research, an indexing giant that now has one of the largest socially responsible investing research shops.
Some mutual fund companies take the outside research and use it as a potential buy list. Others consider it a starting point for their own analysis. The result is it's not unusual for fund managers with similar environmental or social guidelines to look at the same company and come up with different conclusions. The $912 million TIAA-CREF Social Choice Equity fund, for example, invests in what it sees as strong stewards of the environment. But a 2009 study by Trucost made a surprising discovery: The fund's holdings, on average, had a larger carbon footprint than the average company in the S&P 500. Amy O'Brien, a director of social investing at TIAA-CREF, says the retirement-services company weighs environmental factors along with other things, including a company's community investments, labor and human-rights standards, and governance practices.
Of course, no one expects the funds to take a cookie-cutter approach to investing, especially in a business full of judgment calls. Still, some critics say that while it doesn't always matter where the line is drawn, many funds need to make that line much clearer to investors. "These funds are demanding a level of transparency from corporations," says Paul Hawken, who runs a socially responsible fund for wealthy clients. "And yet they themselves aren't always providing it."
Critics have long dismissed socially responsible funds as gimmicks that get in the way of the primary purpose of investing: to make money. Yet for some investors, one reason to put money in a socially responsible fund is to help change the world, even if it's in a small way. The problem is that figuring out whether a fund is achieving change isn't always so easy.
Some socially responsible funds are simply too small to have much clout with companies whose stocks they own. And even with larger funds, victories can be less impressive than they first appear. For example, the Social Investment Forum says some of its members recently reached an agreement with discount retailer TJX Cos (TJX)
Then there's the question of what constitutes activism. Smaller fund companies like Appleseed say they can't afford to do much more than vote on shareholder proposals that are in line with their values. Calvert, one of the largest players in socially responsible investing, is more aggressive. The firm filed 47 shareholder resolutions in the 2010 proxy season, attacking companies on broader issues like executive compensation and climate change, but also on more specific concerns like animal testing and overdraft fees. Private discussions with company executives are also common. "We need investors applying different types of pressure," says TIAA-CREF's O'Brien.
Fund officials say there's a balancing act between divulging details of confidential talks with companies and keeping investors updated. But some financial advisers say spotty disclosure means keeping investors in the dark on issues they care about. Judith Seid, a financial planner in San Diego, says merely investing in companies doing good isn't as effective in changing corporate behavior. "Activism is where real change is made," she says.