In This Chapter

Traditional investors scoffed at an investment selection system that included the choosing or excluding an investment based on a personal value as one of the primary decision points. They reasoned that this value factor could easily exclude investments that were very attractive by every other standard. For example, if all the financial and economic factors pointed toward defense industry stocks as poised for significant growth, SRI investors opposed to these types of investment would miss a prime opportunity. Multiply all the potential missed opportunities (based on the many different types of SRI investors) and it would seem logical to conclude the socially responsible investing couldn’t match the returns of traditional investing strategies. Fortunately, that thinking is wrong, and the conclusions are wrong.

Before we go too far in our discussion of socially responsible investing and return, it is important to put it in a proper context. The most important context applies to all investing, both SRI and traditional, and that is there are no guarantees. Investing is about risk and anticipated reward—not guaranteed reward. If you want a guaranteed return on your investment (therefore, no risk), you should buy a U.S. Treasury Bond or a bank certificate of deposit. When you invest your money in the stock market, in either individual stocks or mutual funds, you are taking a chance that you will earn a reward higher than what a no-risk choice will earn. Over a 70-plus year history, the stock market as a whole has returned an average of between 10 and 11 percent annually. This means if you owned a broad portfolio of stocks that represented the entire stock market and held it for 70 years; it would earn you on the average 10 to 11 percent annually. Some years it would do much better and some years it would do much worse.

As interesting as that is, you can’t assume individual stocks will do the same. Drawing specific conclusions from broad general truths often leads to incorrect answers. Socially responsible investing does require an extra step in the analysis process, but that doesn’t mean it results in inferior investment selections. Some SRI advocates argue that socially responsible investing has outperformed traditional investing because of these extra steps. We’ll look as both sides of this issue.

Socially responsible investors may be concerned with social justice issues, the ecology, or any number of values or causes, but they are also pragmatic investors. Some SRI investors may not be concerned with the return they get on their investment and are more focused on the cause or issue that brought them to socially responsible investing. In the early days of SRI, there were few choices, especially for individuals, so you took what return you could get. But times have changed for the better. SRI is no longer a marginal part on the investment business. Over 200 mutual funds are available for investors to use. Many have similar social

mandates and compete on return. The net benefit to the investor (in mutual funds) is that if your fund is not performing to expectations, there is probably another fund in the market that reflects your social concerns that may offer a better return. More sophisticated screens now allow SRI investors to focus their investments with greater precision.

Measuring the performance of an investment strategy—any investment strategy—is subjective at best. Not only must you examine the soundness of the strategy, but also its execution. A good investment strategy is no better than a bad strategy if the investor doesn’t execute it correctly. You must also consider that a strategy may work better in certain market conditions, but not so well in other market conditions.

Critics of socially responsible investing note that most screens exclude the basic industries, which includes almost all “smoke-stack” manufacturing and some noncyclical companies like cigarette and alcohol products. Detractors point out that by avoiding certain sectors automatically, SRI misses many opportunities for significant gains. Value investors, who look for stocks selling below their true value, often find opportunity in these sectors of the economy. Traditional value investors look for opportunities (think stocks on sale) to buy a stock they believe will rise in price because it is currently undervalued by the market. Many of the most successful investors use this strategy.

Socially responsible investor screens tend to favor technology and service sector companies because they have low ecological impacts. Many are also smaller, new companies managed and staffed by people more in-tune with some of the same issues important to SRI investors. Many of these so-called new economy companies fall into the growth category on the investing spectrum, meaning the company is expected to grow much more rapidly than the economy or other companies. Growth stocks led the stock market in the bull market of the late 1990s—the exact type of companies SRI investors buy, which explains why some SRI portfolios outperformed during that time.

The superior performance of the SRI strategy during this bull market was simply a matter of being at the right place with the right strategy at the right time, detractors argue. A legitimate investment strategy works in good markets and bad, the detractors state. Unfortunately, investors will find very few mutual funds that are successful in all types of markets, regardless of its investment strategy. This will be true for SRI funds as well as traditional funds. It is common knowledge in the investment community that many traditional mutual funds that go on a hot streak for a couple of years often fall hard and fast. The investment strategy the manager was using worked for a particular market condition, but

when market and economic factors changed, his winning game plan fell apart.

In our discussion of mutual funds, we will examine what it takes to make a fund successful and how you can use that information to choose an SRI fund that meets your needs. The issue of return is important because you should not have to sacrifice your retirement fund to invest where you feel comfortable.

However, some SRI investors take up shareholder advocacy as a prime part of their socially responsible investing strategy. This may require you to invest without a thought to return in order to gain access to annual meetings and so on. In these situations, you aren’t typically investing huge sums, so any loss should be minimal and something you can afford.

Community investing poses another situation where, because of the local nature of a project, you have limited choices about where to place your money. If you are going to participate in local projects, the money you deposit or invest may or may not be at market rates. We’ll discuss this in more detail in Chapter 9.

The beginnings of the socially responsible investing movement for individual investors came not from financial professionals, but from people involved in social justice issues. The Pax World Fund was the first mutual fund for individual investors interested in having their investment dollars reflect their personal values. Historically, personal values drove the growth of SRI investing. As the number of investment options grew and SRI became more sophisticated, investors found that they could achieve financial goals without violating personal values.

Recent studies by a mutual fund indicated that financial return is very important to SRI investors. Many SRI investors count on their socially responsible investment portfolios to achieve all of their financial goals.

As we’ll discuss in the chapters on SRI investment products, socially responsible investors have all the tools they need to meet almost any financial goal. While it is obvious that socially responsible investors consider more than just the rate of return on their investments, a large and growing body of SRI investment options provides equal opportunity for SRI investors to meet all their financial needs while being consistent with their values.

Socially responsible investors initially found themselves in an odd position. Traditional, conservative investors scoffed at any investment strategy that considered anything but pure return on investment. Some liberals challenged SRI as selling out to the establishment. As socially responsible investing gained some success in shaping corporate policies and its growth spawned new investment opportunities, those criticisms faded. The reality of SRI is that you can make a statement about your values and earn a competitive return on your investment. Investing in socially responsible mutual funds or building your own portfolio of stocks and bonds that meet your social screens doesn’t assure you of a profit, nor does it automatically mean a loss. Socially responsible investing then is just like traditional investing, there is risk involved and you may lose money. Some investments will earn a better return than other investments. Unless your social screens are extreme, there are ample choices to properly diversify an SRI portfolio. To these choices, you can apply traditional investment analysis tools to select the investments that best fit your portfolio needs and risk profile.

The performance of socially responsible investments is a subject of much concern for its advocates. Early descriptions of SRI as underperforming traditional investments were inaccurate when applied to all funds, but have persisted as perceived truth for many years. SRI advocates can roll out stacks of performance data they claim not only shows that myth to be wrong, but also shows that socially responsible investing outperforms traditional investing. Peter Camejo has written a book on the subject, The SRI Advantage: Why Socially Responsible Investing has Outperformed Financially. His arguments and those of other expert contributors are that SRI screens select companies that are financially strong, less likely to be sued or commit a crime, and are in tune with customers and society. The book was compiled in the 2001-2002 time-frame.

While it is interesting to note their arguments for the value of SRI screens and the performance history of SRI mutual funds, investors don’t profit from the past. The author and contributors make the point that SRI screens can enhance performance, however, no investor buys large groups of mutual funds. Most of us buy fewer than 10 to balance our portfolios. Some investors may buy fewer than five. So, discussing the overall performance of SRI funds as a universe is not helpful. You want to know how to find a fund that matches your values and financial expectations for a return. If SRI funds as a group out perform a similar group of nonscreened funds (traditional mutual funds), but the fund you own is down, that’s the only number that matters to you.

In the chapters on mutual funds, we’ll discuss the factors that help drag down returns, such as expenses. One of the most popular forms of mutual fund investing is in index funds that mimic the performance of a selected group of stocks. The most famous stock index is the Dow Jones Industrial Average. Although it contains only 30 stocks, the Dow is considered one of the most important large company stock indexes in the world. Another popular index is the S&P 500, which includes 500 leading companies. This index is widely considered a proxy for the whole stock market because of its broad composition. The S&P 500 is commonly used by financial professionals as a benchmark to measure performance. For example, investments are said to “beat the market”

if they perform better than the S&P 500. Many traditional mutual funds measure their annual performance against the S&P 500. Several index mutual funds follow the S&P 500. These funds own the same stocks that comprise the S&P 500 and their goal is to match the performance of the index.

The Domini 400 Social Index compiled by KLD Research & Analytics is a comparable index for socially responsible stocks—that is, stocks screened for ecological and social issues. The Domini 400 is used in much the same way as the S&P 500. SRI mutual funds use it to measure performance and index funds exist to track its performance. We’ll discuss the Domini 400 index and its importance more in the mutual fund chapters.

For now, let’s look at the performance of the index relative to the S&P 500 to see how it informs our discussion of SRI and performance. The Domini 400 was formed in 1990, so it has a number of years of operating history. Has the Domini 400 consistently beaten the S&P 500? The answer is no. In some years, the S&P 500 has outperformed the Domini 400 and in other years, the Domini 400 was the better performer. This is not unexpected, despite the enthusiastic claims from SRI investing advocates. Unless you only invest in index funds, it doesn’t really matter whether the Domini 400 was on top one year and the S&P 500 was the winner the next. The reality is that over the life of the Domini 400, the performance of the two indexes was very close. The Domini 400 had a slight edge with an annualized return of 11.87 percent compared to 11.31 percent for the S&P 500 (as of August 31, 2007). During the life of the Domini 400, there have been years when it performed several percentage points over the S&P 500 and years when it underperformed by several percentage points.

Socially responsible investing is no longer considered marginal by many investors and professionals in the financial community. The proven performance of some SRI investments has also contributed to the acceptance by the mainstream investment community. The history of socially responsible investing has shown, you are not automatically penalized by choosing to express your values in where you place your money. Not only that, but there are many large pension funds, university endowments, healthcare organizations, etc. that are SRI investors, which further demonstrates that SRI is quickly becoming a mainstream investment concept.

There are other reasons SRI is considered part of mainstream investing and we’ll explore those in the chapters on issues. People considering socially responsible investing should understand that there is a broad range of opportunities under that umbrella. Finding one that matches your values and financial goals is a matter of doing your homework—just as you would do when examining any other investment opportunity.

Socially responsible investors have argued for years that offending industries and companies pass costs they should be responsible for to others, most often the public. The favorite example is tobacco companies. No tobacco company would be profitable—or even stay in business long—if it was responsible for the health costs associated with tobacco use. The massive national tobacco settlement of 1998 called for tobacco companies to make payments totaling about $246 billion over 25 years. While this sounds like a huge sum, the cost to the country in health care related to tobacco usage approaches $96 billion per year. Tobacco-related deaths top 400,000 per year. The settlement was a slap on the wrist.

Screening out tobacco companies and polluters that often pass the cost of clean up to taxpayers, identifies financially stronger companies that are less likely to face large lawsuits or liability issues because they are better corporate citizens, SRI advocates say. In that sense, SRI proponents argue social screening reduces risk by eliminating companies that may be targets for lawsuits or government actions. Reducing risk while improving return is the ultimate goal of mainstream investing strategies. If socially responsible investing can help investors accomplish this, it can be argued that these strategies fall into mainstream investing.

Socially responsible investors have a full range of investment opportunities, just as traditional investors do. They can also measure the performance of their opportunities against both traditional and special SRI market yardsticks. SRI investment opportunities are best known by the 200 plus mutual funds that have been formed in response to market demand. Although some funds have been around for a number of years, as a group SRI funds are still relatively young and relatively small. Many of the funds will not have lengthy performance histories. Although a fund’s past, performance is not an indicator of future performance it can give you an idea of how the fund might react in different market conditions. This is especially helpful if the same fund manager has been in charge of the fund for five or ten years. And this is true of any mutual fund—SRI or traditional—an investor may be considering.

Socially responsible investors should also consider which type(s) of investments you are most comfortable owning individual stocks, bond, or mutual funds. Most investors own more than one of these and many own all three, however, they may favor one over the others. Each has its strengths and weaknesses.

Mutual funds are the investment vehicles of choice for most socially responsible investors. We will spend Chapters 14-16 looking at mutual funds in detail. With over 200 SRI mutual funds on the market, it is impossible to generalize about their performance. Some have done very well, some have not done so well, and others have tracked about in the middle on performance relative to similar traditional mutual funds.

One of the common mistakes in looking at mutual fund performance is to compare dissimilar funds; that is funds with a different composition and different objectives. The fair and objective comparison is between funds with a common or similar composition and objective. For example, it is incorrect and misleading to compare a growth mutual fund that invests in large companies with a value mutual fund that invests in small companies.

To gain an understanding of how a fund performed, you need to compare it to similar funds and an overall market gauge of some type. This will give you a picture of whether the fund is a “best of class” fund or just another fund in the mix. More about this process will be included in the mutual fund chapters.

As noted earlier, most SRI investors are deeply concerned about financial return and expect their money to work hard while invested in funds that are supportive of their values. With all the SRI funds available to consumers, this is an entirely reasonable expectation. If, as SRI proponents have argued, socially screened stocks are stronger investments, there is no fundamental reason funds built around them should not perform as well if not better than traditional mutual funds.

Of course, some SRI funds don’t perform well. In most cases, you can trace the reasons to faulty management, high expenses, market risk, or other factors. In other words, SRI funds generally underperform for the same reasons traditional mutual funds underperform.

The only factor that may be related to SRI investing is that ecology screens tend to be heavy in technology and service sector companies, while eliminating heavy industry and other traditional “smokestack” industries. When the market favors these companies as it did in the late 1990s tech bull market, SRI funds score impressive gains. When the market shifts away from those sectors, as it did in 2000-2002, some SRI funds can be hurt. The important point to remember is that you aren’t automatically penalized by choosing to consider your values when you invest, however, you must do your homework. SRI funds should be analyzed like any traditional mutual fund. We’ll look at how that works in the chapters on mutual funds.

Many investors carry a number of individual stocks along with mutual funds in their portfolio. SRI investors are no different. Unlike mutual funds, however, there is no one to screen stocks for you, unless you work with a financial advisor. In Chapter 23, we’ll explore this topic in detail. If you choose to do the research yourself, you’ll find research ideas in Appendix A. Investing in individual SRI stocks, which is discussed in detail in Chapter 17, is potentially more rewarding, but carries more risk than investing in mutual funds. It is more risky because if an individual stock goes bad in a mutual fund, it is unlikely to have a huge effect on the fund’s performance because it may be one of 75 stocks the fund owns. If you own the stock individually and it goes bad, you must sell quickly or watch your losses mount. If you are reluctant to sell, as many investors are, your losses may mount until you finally give up any chance of recovery. What should have been a small loss is now a big loss.

Owning individual stocks puts that responsibility on you to sell when the stock begins to turn. Knowing when to sell is a difficult skill to master, which is why so many people favor mutual funds over individual stocks. The fund manager makes all those decisions for you.

The flip side of that problem is the reward for taking the risk of owning an individual stock. It is possible to enjoy a greater percentage increase by taking the risk of owning individual shares. Your chances for greater share price appreciation are higher with an individual issue.

All of these risks and opportunities are generally true for any investor in individual stocks. The extra work comes in screening companies for your values.

Bonds are legal debt obligations of corporations and governmental entities. Traditional bond investors use them to offset the volatility of the stock market and to provide a source of current income. U.S. Treasury Bonds, Notes, and Bills are among the best known, but are not the only bonds available by a long shot. States and municipalities issue them to fund projects from new roads to dams to other civic projects.

With the exception of U.S. Treasury issues, most bonds are sold by the issuer or are negotiated in an inter-dealer market. The costs are hidden, so it is difficult for individual investors to easily understand pricing and so on. Many SRI investors use bond mutual funds for this portion of their portfolio. While a bond mutual fund and an individual bond don’t have the exact same characteristics, the funds are a convenient and easy way to add bonds to your portfolio. SRI bond funds come in many of the same formats as traditional bond funds. The only difference is the SRI bond funds screen the companies behind the bond on a social justice and ecology scale before investing. SRI advocates explain that these screens at the company level can help identify financially stronger companies and safer bonds.

The other primary investment area associated with SRI is community investing. Socially responsible investors saw a need to provide capital to revitalize low-income areas, mainly in our larger cities. People in these communities were often trapped in a cycle of poverty. The early stages of community investing raised money from a variety of sources to help fund low-income housing projects and other programs. Most of the money to capitalize these efforts came from foundations, grants, generous individuals and so on. The return was below market rates because the goal was to provide capital where the private sector was not willing to risk lending.

More recently, community investing has added a sector of proponents who want to attract market-rate capital to fund projects in low-income communities. This is changing the nature of how community investing is structured and who participates. The area of community investing is one of the most exciting to many SRI participants because it allows them to invest in local projects rather than corporations. This local connection includes banks, credit unions, venture capital partnerships, and other financial organizations.

Investors in many of the newer forms of community investment projects can expect competitive rates of return as well as a sense of connection to their community. We’ll explore the whole spectrum of community investment in Chapter 9.