Socially responsible funds grow in popularity
The challenge for companies is deciding which funds to offer as investment
By RACHEL HEPWORTH
East Bay Business Times
At the G-8 summit in Scotland last month, eight participating countries issued a communiqu calling global warming a "serious long-term challenge."
A week earlier, on July 1, KLD Research & Analytics Inc. launched the KLD Global Climate 100 Index, designed to promote investment in public companies working to reduce climate change.
The timing is typical for a company such as KLD, a Boston-based research firm that promotes socially responsible investing. Ever since 1971, when Pax World Fund protested the Vietnam War by refusing to invest in companies with military contracts, investors have banded together to apply personal values to their financial transactions.
Demand for KLD's climate index came from institutional and individual investors whose concerns about global warming had been sharpened by media coverage of the G-8 summit and Kyoto treaty.
The growth in popularity of socially responsible funds has spilled over into 401(k) plans, as individual investors turn to their employers for additional ways to invest.
"If someone is extremely interested in socially responsible investing and their company doesn't offer it through their 401(k), they may be out of luck," said Bruce Fenton, president of financial planning firm Atlantic Financial of Norwell, Mass. "It's the biggest part of their savings, and they can't take that money out themselves and invest it how they please."
Companies have occasionally been reluctant to include socially responsible investment funds, or SRIs, in their 401(k) offerings, fearing a possible violation of fiduciary responsibility.
General theory had held that socially responsible investors had to sacrifice financial performance for social consciousness. Social funds use screens to determine which companies may be included in their indexes, and many profitable industries such as tobacco, alcohol and petroleum rarely make the cut.
But research conducted in the 1990s consistently showed no competitive difference between screened and unscreened funds, and during the past 10 years SRI funds have enjoyed equivalent or greater market gains compared to the S&P 500.
Recent SRI fund performance has slipped over the past five years, as favorite industries such as technology, health care and financial services cooled while "sin" stocks - related to the military and oil - surged.
Over the past five years SRI funds lost 2 percent while all equity funds gained 0.3 percent. Despite recent struggles, financial analysts agree that the use of social criteria to screen out stocks has become an accepted, and profitable, form of investment.
Because socially responsible investors are often focused on results other than financial performance, they are more likely to hold onto their investments through market downturns. The long-term investing strategy of 401(k) plans works in the fund's favor.
"Tobacco is big right now, so are weapons stocks, which generally aren't included in socially responsible funds," said Todd Larson, a project director at the Social Investment Forum, based in Washington, D.C. "But most socially responsible investors are in it for the long term, so the fact that the funds are a bit less competitive right now doesn't mean as much to them."
As of May, Morningstar Inc. listed 18 socially responsible funds that rated at least four stars and had expense ratios of less than 1.5 percent. SRI funds are now available in almost every combination, from small- to large-cap, domestic to international, pro-labor to anti-military. The challenge for companies is deciding which funds to offer as investment options.
"Employees have so many different desires and definitions for socially responsible funds," said Fenton, of Atlantic Financial. "For some, social responsibility means providing equal employment benefits to all employees, including same-sex couples. For others it means preserving traditional family values. Most companies end up trying to avoid the worst of the worst."
Recent innovations in funds' expense ratios and diversification have given employers a range of socially responsible choices that are more profitable and less risky.
SRI funds have benefited from lower expense ratios. While such funds tend to be actively managed, incurring high costs, new low-cost options have emerged.
TIAA-CREF Social Choice Equity, which screens out alcohol, tobacco, gambling, weapons and nuclear-energy companies from the broad Russell 3000 Index, boasts an expense ratio of 0.27 percent. Vanguard Calvert Social Index VCSIX, which invests heavily in the tech and health-care industries, does even better with an expense ratio of 0.25 percent.
In January 2005 Barclay Global Investors launched iShares KLD Select Social Index. The fund's expense ratio of 0.5 percent puts it 1 percent below the average for mutual funds, but perhaps more important, it is the first socially responsible exchange traded fund.
ETF's, like mutual funds, hold a broad index of stocks and are generally low cost. They differ by allowing trades all day long, exploiting market fluctuations, instead of setting net asset value once a day.
ETF's are hot in today's market; their popularity stems from their tax and cost efficiency and flexibility. Barclay's index means that socially responsible investors can now take part in the ETF craze.
Socially responsible funds tend to skew towards small technology companies, which more easily comply with high environmental and corporate governance standards. Tech's volatility, along with SRI fund's refusal to invest in stable and profitable industries such as oil, have discouraged risk-averse investors.
While diversification is more difficult with socially responsible investing, it is possible. Pax World Balanced Funds, for instance, counts BP among its holdings, due to its development of renewable energy and efforts to minimize spills.
The Pax World Fund practices best-in-class investing, as opposed to maintaining strict social screens. Best-in-class investors hold stock in the least offensive companies in problematic industries, such as oil, natural resources and energy. While it may be difficult to achieve a diversified portfolio using strict social screens, best-in-class criteria permits investment in a wide range of fields.
Changing focus of SRIs
The KLD Select Social Index Fund offers a twist on best-in-class investment. The fund invests in all sectors of the economy except tobacco, overweighting companies with strong social and environmental performance and underweighting those with a poor sustainability record. It is one of the lowest-risk options available to socially responsible investors.
Companies typically introduce SRI options after requests from employees. Creating a social investment option can have a spillover effect of not only pleasing current employees, but helping to recruit workers as well, says Lloyd Kurtz, senior portfolio manager with Nelson Capital in Palo Alto.
"Social investing has taken a lot of share in the investment world; people want it and they like it," said Kurtz. "Especially for West Coast, companies that have a lot of human capital and are competing for talent, there is real motivation to introduce such funds."
Universities - exactly the type of progressive institution likely to be at the forefront of socially responsible investing trends - often include such funds after lobbying from their students. UC-Berkeley now includes Vanguard Calvert Social Index Fund in its list of core offerings.
One out of every nine households in the United States defines itself as a social investor, and such investing has grown 40 percent faster than all professionally managed investment assets in the nation. That growth has been spurred by powerful institutional investors that control a large portion of California's pension plans.
KLD Index Managing Director Thomas Kuh cited such pension funds in KLD's decision to launch the Global Climate 100 Index.
"Pension funds are concerned about the financial risks associated with climate change," he said. "As fiduciaries with a long time horizon, they are looking for new strategies to integrate these factors into their investments. The Global Climate 100 looks ahead to show investors where the opportunities to ad-dress global warming will come from."
Lowering expenses, increasing diversity and a growing track record of success have made socially responsible funds a popular option for employers looking to stay at the forefront of benefit options. But in the end, socially responsible investing is almost as much about the image a company wants to portray as it is about offering different investing strategies to its employees.
"By offering a socially responsible 401(k) option a company is signaling to its employees that it's important to act like a good corporate citizen," said Kellie McElhaney, executive director of UC-Berkeley's Center for Responsible Business.
07 September 2005
( 2005 American City Business Journals Inc.)