In This Chapter

In previous chapters, we discussed the many benefits of using mutual funds for socially responsible investing. The professional management, diversification, and ease of investing make a compelling case for these funds. A mutual fund’s knowledgeable staff that checks the social and environmental screens and engages in shareholder advocacy benefits investors looking to invest in situations compatible with their values. But some investors want more control over their investments. They may object to what they consider inordinately high expenses or they may just prefer to get their hands dirty when investing their money—do the research and so on themselves.

Whatever their motivation, these investors want more control over their money and more interaction with the companies they own. Thanks to a number of resources, it is possible for individuals to discover many SRI aspects of individual companies. Many companies are issuing environmental or sustainability reports. Other sources of information exist that compare companies standing on SRI issues. Individual investors can file shareholder resolutions and many do. Bonds, which are loans to governments and corporations, also play an important role in investing and a growing role in SRI investing.

Owning individual stocks (as opposed to shares of a mutual fund) offers investors several benefits and poses several challenges. From a pure investment perspective, many investors only own individual stocks, while a great many more only own mutual funds. A smaller number own both, which is probably a smart strategy. Not every investment professional will agree with that statement. Some say stick with mutual funds and let a professional make those hard decisions for you. Others say there is no reason to pay ongoing expenses that eat away your profit, when holding a stock doesn’t cost a thing. From the SRI perspective, mutual funds can provide a much better job of screening funds—if they do their homework, but individual investors can do a good job if they follow some simple steps.

From an investment perspective, owning individual stocks (as opposed to shares of a mutual fund) offers some distinct advantages. One big advantages is no ongoing expenses to eat away at any profits—or to add on to a loss. You will pay a stockbroker a fee when you buy the stock and when you sell. More important, investors gain a more intimate knowledge of the company behind the stock when looking after eight to ten individual stocks in a normal portfolio. Mutual funds that own dozens of stocks (index funds may own hundreds) don’t provide much opportunity for investors to fully understand the company.

If you own individual shares in a company, you are a direct owner of that company, unlike mutual funds where you own shares in a fund that owns shares in the company. This direct ownership means the company deals with you in matters of proxy votes, dividends, and so on. In addition, you don’t have to pay for the privilege of being an owner. Thanks to discount stockbrokers, commissions are quite low and that’s the only cost (other than taxes on dividends) of owning shares of stock. You pay another commission when you sell the stock and possibly a capital gains tax on profits.

Remember, going it alone in the investment world is just that. Unless you pay for investment advice, you must do your own research and decide which stocks work best for your portfolio. You’ll want to monitor the companies behind these stocks to make sure your original reason for buying the stock continues to make sense. If a stock begins a dramatic decline, do you sell or ride it out hoping the price will rebound? You’ll have to decide if the drop is due to something wrong with the company or its market. When all of these decisions are yours, some investors see the benefit of paying professionals at mutual funds.

But even these challenges don’t deter the true believers, because they enjoy this type of investing and they know that all things being equal, your chances of making a higher return on your investment are with individual stocks and not mutual funds.

There is an existing system of information sources and support to help investors buy and sell individual shares of stock. What about doing socially responsible screening though—how hard is it for individuals to do that type of research? It is not as easy as researching the financials of a company because the government requires an open-book reporting policy for companies that trade on public stock exchanges. For the most part, that requirement doesn’t extend to socially responsible areas—those areas aren’t defined that way for easy researching.

Companies must report major legal and regulatory actions to shareholders and those filings are a matter of public record. You can find them at the Securities and Exchange Commission website and through several free and paid sources. See Appendix A for more information on where to locate these resources. These reports are not the easiest to decipher, but major labor relation actions such as discrimination settlements, union arbitrations, and so on are reported here. In addition, if the company has major findings against it by the Environmental Protection Agency or any other federal or state regulatory agency, you should be able to locate those. Another good source of information is to Google the company and check out the news archives for stories on any legal problems the company has had.

The searches won’t uncover the problem that hasn’t been reported yet or isn’t severe enough for civil or criminal action yet. A good SRI screening by a mutual fund or a screening services may pick up this type of problem that an individual investor might have a difficult time uncovering.

One answer to the research problem is to let mutual funds do it for you. Either through funds that you own or by researching funds, you can often discover what companies SRI funds own. This gives you a pre-screened list to start your personal research. The key is understanding what screens the fund applies and how those screens fit with your values.

For many SRI investors, the point of owning individual stocks is so they can do the screening and selecting themselves. They feel more comfortable about investing when they have done the legwork to their standards. The same is true of the SRI standards. As we have previously noted, socially responsible screens come in a variety of levels of thoroughness.

A do-it-yourself investor likely has specific ideas about what the company should look like from an investment perspective and what SRI standards it should meet. These investors are not usually eager to turn over either type of research to another party. Fortunately, many tools available to individual investors make sophisticated research possible for little or no money. SRI research lacks the depth of tools that traditional investing offers, but resources are available for individuals to help them with that aspect of socially responsible investing.

The Internet has opened a huge amount of information to investors willing to do their own research. The tools to process the volumes of information are surprisingly robust considering many are free or available at modest costs. Stock screens, profiles, commentaries, and more are all available online and, for the most part, free.

Many major information sites provide a variety of stock selection and qualification tools. Some sites provide a basic level of service and offer a higher level of offerings for viewers who choose to subscribe to a premium service. For example, MorningStar.com, one premiere websites on the market for mutual funds and stocks offers pages of free information and commentaries. The information includes investing lessons as well as market news and educational articles on a variety of investing and personal finance topics. Investors are becoming more sophisticated in their knowledge of investing and the available tools. The better online brokers usually offer tools for portfolio management and stock/fund selection. Most tools are straight up returning unbiased recommendations. However, investors should be alert to the possibility that some online calculators may be stacked in favor of encouraging customers to buy more stock, mutual funds, or other securities.

Financial screens help investors sort through the thousands of stocks or mutual funds to narrow down the field for consideration. These screens consider financial data and ratios only, so are only suitable for the investing side of the decision. But they do a good job at cutting through mountains of financial data to help investors in the initial selection process. The screens limit the field to a smaller number for the investor to pursue further.

Investors can use the pre-set screens offered by some sites or construct their own using easy to understand menus. These screens examine fundamental financial information and ratios. Investors can sort though thousands of stocks or funds in seconds to find the targets that fit the parameters they enter into the screen. Some screens offer a basic service at no charge and a premium version for a small subscription fee. The premium screens can be quite sophisticated in the parameters you can look for in a company. Some very high-end tools perform complicated analysis on stocks or groups of stocks, but most investors don’t need this level of sophistication.

The financial side of investor’s investigations is just part of the process for socially responsible investors. Investors must also screen the companies based on their values and the issues that are important. When an individual acts alone, it may be helpful to find a sympathetic listener who lets you talk out your SRI positions. The act of explaining your values to another person is a good way to be focused on which social, ecological, and governance issues are important. Articulating your goals, writing them down are good ways to set them firmly in your mind and prepare for doing your due diligence on the values portion of the investment.

As noted above, reading a company’s annual report, 10-Q form, and other required filings will alert you to major civil or criminal infractions. Likewise, a review of news media articles using an online search engine such as Google will help investors spot any red flags such as boycotts, labor disruptions, or other incidents that land the company in the news.

A growing number of companies are providing SRI type reports along with the usual and required financial disclosures. Most reports are not required by any regulatory body, however they are reviewed for misleading or fraudulent statements that might lead a person to buy the stock under false pretenses. These reports, despite the regulatory review, are not likely to put the company in a bad light, even if that’s where they deserve to be. They can be a starting place for further investigation. Caution should be used is accepting reports of ecological or socially responsible activities as absolute truths. Some companies spend more money promoting their good deeds than they spend of the actual deeds themselves. This tells you where their motives are.

An example of research available to individual investors is the website www.cookingyournestegg.org. The website focuses on global warming and looks at the top 24 mutual funds, but individual stock investors can use its results to find information about companies they may be considering. Many of the funds are large cap, growth funds, so it is skewed that direction, but the information is helpful if those are the companies you are considering.

Although the website was designed to help people see the global warming exposure they may have through the mutual funds they own, individual stock investors can use the tool also. The calculator asked you to select the funds you want to review and when you submit your list, it shows you the companies in each fund with financial risks to global warming issues. You can click on the company name and get specific information about why the website believes this is the case. The reports also list companies that have taken or are taking steps to improve energy efficiency, reduce greenhouse gases, and other measures to reduce financial liabilities for global warming issues. You get a look at both negative and positive reports on global warming issues.

Unless you are looking at small cap stocks, there’s a good chance the companies you are considering are in one of the mutual funds—especially since several are broad-based stock index funds.

A problem facing the whole SRI investing community is the lack of a universal definition for the many terms that make up the process. The current term that is on everyone’s lips is sustainability. How sustainability is defined depends on who you are talking to and about what. We’ll get into a more detailed discussion of sustainability in Chapter 21, but for now, the debate raises an issue for individual investors. How do you decide which companies are in and which are out based on the social and environmental screens you assign from your values? We all accept that no companies are perfect, so at what point do individual stock investors say, “This is as far as I will go. Anything beyond this point is grounds for excluding the company.”

Even if it is not articulated in that manner, mutual fund managers and other professional investors reach the same decision. Given that social, environmental, and governance information may not be as hard and clear as financial ratios, these decisions are always subjective to some degree. If you are able to articulate the most important three values and make them your absolutes, it is easier to address the lesser concerns on a case-by-case basis. For example, you could say my most important three values are:

If a company scored perfect on all three of these, could you overlook a settled discrimination suit if it appeared the company had ended the illegal practices? Investors must be prepared to make these types of decisions and compromises. Nothing is magic about holding fast to three primary values, however, you should consider some small number as primary values and others as secondary. This allows you to stand fast on your primary values and consider the secondary values as somewhat negotiable.

Individual investors have the same rights as mutual funds and institutional investors to bring shareholder resolutions and other advocacy actions to a corporation. It will be more difficult because the process can be cumbersome and time consuming, but a determined individual can prevail.

Corporations have the right to request shareholder resolutions be denied, but they must meet certain conditions before the Securities and Exchange Commission will rule in the company’s favor. If shareholders understand the rules and craft their resolutions so the SEC can find no fault under its regulations, there is a good chance it will go to a proxy vote. Shareholders who bring resolutions to corporations also have the option of entering a dialogue with the company to resolve the issue before it comes for a vote.

Corporations pay more attention to blocks of votes, but individual shareholders still must be reckoned with when it comes to shareholder resolutions. It takes a determined individual to follow a shareholder resolution issue through the process, but if you follow the regulations, it can be done.

If you have a legitimate issue and one that might be opposed by management, be prepared for a campaign of letters and phone calls suggesting you are not acting in the best interests of the company, all designed to make you back off your action. The company can’t go very far with this campaign without running into securities laws, but some will push the limits. The other popular tactic is the “we can’t do that because…, but we’re already doing this and it’s just as good or better.”

If the company want to settle and avoid a shareholder resolution, make sure what they proposed actually accomplishes what you want or substantially most of it. Also, make sure there is a public statement that the company is going to do X or no longer going to do Y. Any agreement should be in writing and made public. This is insurance that the company will follow through with anything it commits to do behind closed doors.

Investors should keep some assets in bonds to counter the volatility of stocks—that is an important rule of investing. Stocks, bonds, and cash are considered the three primary asset classes that make up portfolios. Stocks, which can be individual stocks or stock mutual funds, offer the best chance for rapid growth and usually come with the highest risk. Bonds and bond mutual funds counter the volatility of stocks by moving in the opposite direction of the stock market—when stocks are down, bonds usually rise, and so on. But the potential return from bonds, which is current income, is lower than stocks, but also less risky. Cash is usually the safest investment and offers the lowest return.

Most information you can find about socially responsible investing discusses stocks and stock mutual funds. So far, that has been true in this book, also. There is a good reason for that. The selection of SRI bond funds is limited compared to stock funds. Buying individual SRI bonds (meaning bonds from companies judged socially responsible) is not easy or inexpensive, although many investors own individual corporate bonds. Corporate bonds do not offer any tax advantages like municipal or U.S. Treasury bonds offer.

Individuals can buy corporate bonds through stockbrokers that carry bonds (not all do). The process is not the same a buying stock and you may have a difficult time because SRI investors want to buy bonds from specific companies. The typical bond investor will ask a stockbroker to find a bond with certain characteristics, such as maturity, rating, coupon rate, and so on. The stockbroker will try to find such a bond in the inventory the company owns and fill the order. If the stockbroker’s firm does not have a bond to fill the order, it will buy one from another broker and fill the order that way. An SRI investor will ask for a bond from a specific company because of its SRI rating. The stockbroker will

have to find another broker that holds that bond and buy it for resale to the investor. All of these transactions begin to build substantial sales charges and fees to the investor.

Investing in individual corporate bonds has some advantages from the investment side of the process. Corporate bonds tend to pay the highest coupons or interest rates of all bonds. They can provide a steady stream on income for years, which can be especially useful to people in retirement. At maturity, you get your original investment back. For example, a 10-year, 7 percent corporate bond with a face value of $1,000 will pay an investor $70 per year for 10 years and then return the $1,000 face value.

Investors can hold bonds until maturity or they can trade them before maturity. Corporate bonds can be bought at issue or in the secondary market through a stockbroker. The steady income and return of principal are factors that help retired people manage their assets. Rating companies help investors judge the creditworthiness of various corporate bond issues. The higher the rating, the lower the interest rate.

Owning individual bonds for any period can be risky. If interest rates rise substantially, you are locked into a lower paying security. The only way to get out of the lower paying bond is to sell it at a discount (for less than face value). Corporate bonds are subject to being called, which means if interest rates fall, the company could issue new bonds at a lower rate and buy the existing bonds off the market. You would get the principal back, but lose a source of higher interest rate.

Buying and selling individual corporate bonds can be expensive in fees and charges. Most financial advisers suggest you not consider individual bonds unless you are able to commit at least $25,000 and up to $100,000.

The importance of bonds in individual portfolios, but maybe more important in the holdings of institutional investors has created the need for SRI bond funds. Most traditional bonds are held in bond funds and by institutional investors. For most SRI investors, bond funds make the same sense as stock funds do. They combine all the positive elements of stock mutual funds, which are even more important for bonds. The downside is there are not that many to consider.

Bond mutual funds, like their stock counterparts, are easy to get started. Most will set up an account for $1,000 to$2,500 initial deposit (although some require up to $5,000 minimum) and will do automatic withdrawals from your checking account. The funds allow you to make withdrawals, which is much more convenient than selling individual bonds on the open market. The funds vary from no-load to loaded share classes. See Chapter 13 for an explanation of sales expenses and share classes.

A key factor for most SRI investors is the professional management of SRI bond funds. The bond market is a sophisticated and complicated network to navigate. It takes a specialized knowledge that professional managers can bring to funds. Few individual investors have the time or expertise to track the market. Socially responsible investing bond funds often are not pure stock funds. They may include U.S. Treasury issues, mortgage pass throughs, municipals, and other debt instruments. You’ll want to check the prospectus thoroughly to see how much of the fund is actually invested in SRI corporate debt and how much is invested in the same debt instruments as traditional bond funds. If you want to be as pure of SRI investor as possible, you want to check out the composition of the bond funds carefully before investing.

Several SRI bond funds focus on foreign bonds. These funds represent the safest way to invest in foreign debt. Foreign SRI bond funds are on the rise and more will be available in the U.S. market as interest in socially responsible investing continues to grow.

Specific risks to investing in foreign debt make using bond funds a good idea. Foreign currency exchange rates, political and economic unrest, different social values, and so on make investing in foreign bonds more challenging than U.S. debt instruments. A good fund manager and research team will earn their expenses in a foreign bond fund by doing the difficult research and making wise buy and sell decisions.