The growing number of socially responsible mutual funds offer investors both proven performance and diversity.
by Philip Johansson, SRI World Group News Editor
If variety is the spice of life, then socially responsible mutual funds are the jalapeņos and habaneros of the financial industry. While most investors merely chew through the monotonous financial details of price-earnings ratios, valuations, and economic indicators, social investors add a generous measure of spicy social and environmental variables into the mix. Social mutual funds range from those that merely screen for specific issues, such as tobacco, animal welfare, or minorities, to socially responsible jambalayas combining broad-based screens, shareholder activism, and community investment. After 30 years of growth and development of new products, social investing offers mutual funds to please every palette.
Of course, even spicy portfolios need to include appetizers, main courses, and desserts. Equally important in the growth of social mutual funds has been the increasing variety of investment styles and capitalization, or the size of companies held, that allow a well-balanced portfolio. While the past decade has seen impressive performance among social mutual funds, led by the Domini Social Index's consistent outpacing of the S&P 500, the majority of the action has been in large-cap, growth-oriented funds favored by the market in recent years. The challenge of the next decade will be to see if socially responsible portfolios including a wide range of classes, now finally available, will hold up as well.
For a sneak preview of which funds to watch, we look at 21 of the best performers from a variety of investment classes. These socially responsible mutual funds each outperformed the respective benchmarks for their category, based on three-year average annual returns for the period ending April 30, 2000. Of course, there is a risk that taking such a short view of fund performance can skew results, particularly given the dramatic market in the last year or so. But many of the most exciting social funds have not been around much longer than three years so would be missed by a longer view. We even include a handful of funds that have been around for less than a year (see Six New Funds to Watch), but have futures so promising that they bear mentioning.
About the Ratings to top
First, a word about ratings. The Morningstar ratings listed for each entry in the chart, between one and five stars, are indicative of the fund's risk-adjusted performance, based on a weighted average of three, five, and ten-year (if available) ratings. The funds that perform in the top 10 percent of all for that category earn five stars, the second 22.5 percent earn four stars, the third 35 percent earn three stars, etc. The social ratings, indicated by between one and five hearts, are not to be confused with menu items that are beneficial for cardiovascular health. These were developed by Jack Brill of Natural Investing Services, in San Diego, to evaluate the social performance of funds in the area of negative screening, positive screening, shareholder activism, and community investing. Funds that scored more than 80 out of 100 based on Brill's criteria earn five hearts, more than 60 earn four hearts, etc.
Large Cap to top
The majority of socially responsible mutual funds over the years have been large-capitalization funds, and they still represent the heart of the industry. Dreyfus Premier Third Century is the grand-daddy in this category, conceived in 1972. Now with assets over $1 billion, Third Century is the lone social fund at Dreyfus, which has some 150 funds overall with total assets of $110 billion. Social research for Third Century is conducted in-house by Paul Hilton, who conducts positive social and environmental screens with the stated goal of enhancing the quality of life in America. Although being part of a large, mainstream financial services firm precludes filing shareholder resolutions, Hilton is very active behind the scenes collaborating with other major shareholders to bring corporations to the negotiation table on social and environmental issues. Third Century also has a portion of its assets in a certificate of deposit with Self-Help Credit Union, which shares this capital with underserved communities, leading the recent trend mutual fund involvement in community investments. With a three-year average return of 27.21 percent, Third Century also handily beats the S&P 500 benchmark of 23.70. Not bad for an old geezer.
No discussion of social funds would be complete without mentioning Domini Social Equity Fund, another $1 billion-plus social fund. "It's been a standard-bearer in the social investing world," said Emily Hall, Editorial Analyst for Morningstar, a leading investment research firm. "Because of its strong record over a long time, it has challenged the theory that you automatically surrender your wallet if you want to invest according to your values." Managed by Domini Social Investments of New York, for the past nine years the fund has tracked the Domini Social Index, a socially screened alternative to the S&P 500 created by Kinder Lydenberg & Domini (KLD). Domini Social Equity is a passively managed fund composed of approximately 400 companies, mostly large firms, which pass multiple social and environmental screens. But Domini Social Investments has done much more than write the book on broad-base screens. The fund is also very involved in shareholder activism, filing or co-filing ten shareholder resolutions this year and leading a three-year dialogue with Walt Disney voer global labor standards. Domini pioneered publishing its proxy voting policies and specific votes on issues, and encourages shareholders to invest in the Domini Money Market Account at South Shore Bank, a leading community development bank.
Citizens Index is the other large-cap index fund to watch out for among the social responsible choices. Managed by Citizens Trust of Portsmouth, NH, it has been around long enough to prove it is here for the long run, with a 3-year average return of 30.57 percent, more than 5 percent higher than Domini Social Equity. Citizens uses somewhat tighter screens than Domini, sifting only 200 stocks from the S&P 500 as opposed to Domini's 250, with a resulting list of 300 holdings. Additional screens employed by Citizens include animal testing and the AFL-CIO's company boycott list. Shareholder activism is also a high priority for Citizens, which filed or co-filed shareholder resolutions this year on genetically modified foods, board diversity, sexual orientation policy, vendor standards, and signing the CERES principles for environmental conduct. Another example of Citizens' investment in social change is their recent Corporate Citizenship Awards to 12 companies outstanding in the areas of environment, community, diversity, and other issues.
Two funds that were designed as clones of the Domini Social Equity Fund, and have had similar positive performance over the past three years, are Green Century Equity and DEVCAP Shared Return. Green Century tracks the Domini Social Index right along with its namesake fund, but with a higher expense ratio of 1.5 percent versus .95 for Domini. What makes Green Century special is that the profits go to Green Century Capital Management, a consortium of nonprofit organizations including U.S. Public Interest Research Group and its regional affiliates, giving the fund an extra layer of environmental responsibility. These green roots keep the fund active is shareholder advocacy, for instance filing a shareholder resolution at ARCO this year to cancel oil-drilling plans in the Arctic National Wildlife Refuge.
DEVCAP, also designed to mimic the Domini Social Equity Fund gives investors the opportunity to allocate all or part of their fund appreciation to micro-enterprize development in Africa, Asia, and Latin America through Catholic Relief Services. While this exciting international community investment opportunity at DEVCAP will continue, the fund announced this year that Christian Brothers Investment Services would be its new investment manager, adding substance to the usual disclaimer, "past performance does not guarantee future results."
The littlest guy near the top of the list of performers is Bridgeway Social Responsibility, with shy of $6 million in assets. This fund is managed by John Montgomery of Bridgeway Capital management, which also runs several other small non-screened funds. Bridgeway takes a unique approach to social screening by putting the horse before the cart, so to speak, and applying screens before financial models. Using the Council on Economic Priorities database of 723 companies, Bridgeway ranks them from top to bottom using social criteria. These criteria, in turn, are provided by fund investors themselves, in an unrivaled example of corporate democracy, with environment, family benefits, and charitable contributions coming first. The fund then takes the top fifth from the ranked list, or 145 stocks, and employs financial models to screen them further. Bridgeway's methods for selecting the most exemplary companies, and of sharing 50 percent of all profits with charity, makes them worth looking out for.
IPS Millennium is another promising up and comer, topping the list with 44.67 percent three-year average annual return, nearly twice the S&P 500 benchmark of 23.7 percent. At five years old, the fund's rank is largely due to its remarkable performance last year, a stunning 118 percent, the most of any Growth and Income fund. This $400 million fund is managed by Robert Loest, an unconventional portfolio manager who uses biological concepts and Complex Adaptive Systems (CAS) theory to select stocks. Although Loest does not state any social or environmental screens by prospectus, he affirms that IPS's management policy based on ethical criteria covers all the usual bases, and a few more.
The final two top-performers in the Large Cap category are niche funds designed with particular religious inclinations in mind. These represent the borderlands, the gray area between ethical or social investing and more morally-laden, values-based investing often contrary to progressive social investors, a potent example of the "spice of life." Noah Fund represents the social concerns of conservative Christians, including "family values" such as avoiding same-sex "domestic-partner" benefits and abortion, as well as exclusionary "sin" screens like alcohol, tobacco, gambling, and pornography. American Trust Allegiance Fund was designed with Christian Scientist investors in mind, and in addition to "sin" screens excludes investments in any pharmaceuticals, biotechnology, or diagnostic products. Although representative of a religious niche fund, with a three-year average return of 37.53 percent. American Trust Allegiance Fund may be a niche more social investors should consider!
Mid Cap to top
Another member of the Citizens family shines in this category. Citizens Emerging Growth gained an eye-popping 55.07 percent three-year average return, easily more than twice the S&P 400 Midcap benchmark of 24.73 percent. Even with the high expense ratio of 1.83, those kinds of returns could make the most level-headed investor salivate. Although social research for this fund is still managed in-house by Citizens, employing the same rigorous social screens as in the Citizens Index, its $300 million in assets are managed financially by Senecca Capital Management in San Francisco. Because of its high turnover, over 200 percent, Emerging Growth has little opportunity to file shareholder resolutions with companies, but the fund is active in shareholder advocacy through dialogue.
Parnassus Fund is the dark horse of socially responsible mutual funds, named after the mountain in central Greece where the Oracle of Delphi was found. Portfolio manager Jerome Dodson takes a "contrarian" approach to investment, meaning he seeks stocks that are currently out of favor with the investment community, but applies a comprehensive set of social and environmental screens as well. Although the fund's performance for the three-year period was formidable, at 47.39 percent, it is widely considered an aggressive, volatile, and high-risk fund. "At one point it had up to 75 percent of its holdings in technology," said Hall. "So it's a more aggressive fund than some people would want."
The other two top-rated funds in the Mid-cap category are once again religious funds, illustrating that the more specialized social programs of religious investors can also be consistent with performance. For instance Amana Growth Fund, created for Islamic investors, screens out many financial stocks because of an Islamic principle against usury. Apparently it doesn't miss them either, as this fund beat the three-year average return benchmark by almost 4 percent with 28.35 percent. Aquinas Equity Growth Fund, geared toward Catholic investors, is also unique in that it only screens out the most egregious of companies for matters such as abortion and contraception. While Aquinas does not often participate in shareholder resolutions, it engages many companies on social and environmental issues with remarkable results, including GE's decision to promote women to top executive positions and NBC's position as the least violent TV network.
Small Cap to top
Only one fund makes the cut above the benchmark in the Small Cap category, the Russell 2000, illustrating the scarcity of social funds in this investment class. Calvert New Vision Small Cap (A Shares) is representative of nine socially responsible funds run by Calvert Group of Bethesda, Maryland, the largest family of SRI funds in the U.S. Calvert does much of its own social research, employing a bevy of six social analysts devoted to specialized areas, and is considered a leader in this field. For instance it recently introduced an indigenous peoples rights investment policy, the first of its kind among U.S. funds addressing the struggles of indigenous populations worldwide to retain their land and cultures. In addition, Calvert Group's association with its non-profit spin-off, Calvert Foundation, allows some fund assets to be channeled to disadvantaged communities around the world in a unique community investment component. But the $76 million New Vision Small Cap is strictly a screened fund, giving little pretense toward shareholder resolutions or community development.
Balanced to top
Here is another category where social funds have made a significant contribution, led by Pax World Fund, the first fund to employ broad-based social screens in 1971 and a consistent performer ever since. With a 21.21 percent three-year average return, Pax World Fund beat the benchmark, a blend of 60 percent S&P 500 and 40 percent Lehman Brothers Aggregate benchmark, by almost 5 percent. The $1 billion-plus fund, managed by Robert Colin and Christopher Brown and the serious research department of Pax World, aims to invest in "life-supportive" companies with good records in environment and employment practices. Pax is taking a lead position in promoting the recycling of computer components, and is becoming more involved in shareholder advocacy, being the second mutual fund to publish its proxy voting results. Pax World has allocated $1 million of its assets to community investing through a deposit in South Shore Bank, a leader in community development banking. The fund is also affiliated with Pax World Service, a nonprofit organization that sponsors friendship tours to developing countries for projects such as building houses or planting trees.
Another bright light in the Balanced category is Green Century Balanced Fund. Although this fund is also run by Green Century Capital Management, which administers the Green Century Equity Fund, this is a totally different animal. Managed by Winslow Asset Management's Jack Robinson, this fund is a sterling example of "positive" screening, specializing in companies that have clean environmental records, many of which make positive environmental contributions such as solar and wind power companies. With a total return of 76.39 percent last calender year, the top balanced fund tracked by Lipper for the same period and enough to make anyone's windmill spin, Green Century Balanced fund is still not for the faint of heart. "It's filled with tiny-capitalization companies, mostly technology firms," said Hall. "Overall, it's a niche product, designed to be close to a pure-play green offering." In other words, for investors who have other solid core holdings, Green Century Balanced could be a sprightly green piece to add color to their portfolio.
The other Balanced funds that beat the benchmark are Smith Barney Concert Social Aware (A shares) and Parnassus Equity Income. The Smith Barney fund was a regular, unscreened balanced fund until February 1997, so the respectable three-year average return of 18.83 percent barely represents its entire socially responsible career. Concert Socially Aware has straightforward screens for tobacco, employment, and the environment. But this $350 million drop in the bucket for Smith Barney, a subsidiary of the $700 billion Citigroup, is not likely to file shareholder resolutions and shows no movement toward community investment. Parnassus Equity Income has been around much longer, since 1992, and employs social screens that are considered among the most rigorous. Also managed by Jerome Dodson, The Equity Income Fund may invest up to 10% of its assets in community loan funds that finance economic development and low-income housing.
Fixed Income to top
The pickings for socially screened fixed income funds are noticeably leaner. Only one fund, Eclipse Ultra Short Term Income Fund, beat the Lehman Brothers Aggregate benchmark by a hair with a three-year average return of 5.51 percent. At $7 million in assets, this tiny bond fund with a big name is another socially responsible nugget nested within a family of more conventional funds. It's managed by Wesley McCain and Joan Sabella of New York-based Towneley Capital Management, with social research by Kathy O'Connor, who also Co-Chairs the Social Investment Security Analysts Group. For over ten years, Towneley has managed accounts with customized social criteria, adding social criteria to the Eclipse Ultra Short Term Income Fund. Although the fund excludes alcohol, tobacco, defense, nuclear power, and gambling, there is little more to its social agenda than these exclusionary screens.
Global/International to top
With the movement toward globalization and the growth of socially responsible investment industries in other countries, the international market is an exciting new terrain for social investors. Citizens Global Equity is the third member of the Citizens fund family to turn up, confirming Citizens' rightful reputation of the best family of social funds for one-stop-shopping. In this case, Citizens Global Equity left the benchmark in the dust, at 38.61 percent for a three-year average return versus 14.20 percent for the benchmark, a blend of 60 percent MSCI World and 40 percent LBA. These remarkable returns were achieved with Citizens careful social research and partnering with international NGOs, especially focusing on human rights issues, confirming that there really is hope for the world after all.
While Citizens Global Equity is a "global" fund, including U.S. companies, MMA Praxis International (B shares) is an "international" fund investing only overseas. Barely three years old, MMA Praxis International beats the benchmark, MSCI EAFE, by almost 5 percent with 19.27 percent. This fund is managed by MMA Praxis, an affiliate of Mennonite Mutual Aid, which offers diverse financial services to help Anabaptists practice biblical stewardship. Although certainly the most progressive, this last of several top-performing religious fund certainly suggests that there must be some higher force looking after them all. Regardless, MMA Praxis employs positive screens and a level of engagement with companies that is more typical of their European counterparts. It also recently engaged in a community investment component through a partnership with Calvert Foundation.
Six New Funds to Watch to top
Vanguard Calvert Social Index Fund is the collaboration of Calvert Group, a leader in socially responsible investing, and Vanguard Group, the second largest mutual fund firm in the U.S with $550 billion in assets and 14 million accounts. Launched in May, this fund represents a significant step in the mainstreaming of social investing employing broad-based screens to pick stocks from 1,000 of the largest companies in the U.S.
Domini Social Bond Fund, launched in June, is the first mutual fund managed by a community development financial institution (CDFI), South Shore Bank. The fund employs the same social screens as the Domini Social Equity Fund, but combines investment-grade bonds with community investing to provide opportunity for underserved communities.
Friends Ivory European Social Awareness Fund is the first Europe-only social fund for U.S. investors, launched in February. Managed by Friends Ivory Funds, an affiliate of the oldest socially responsible fund manager in the U.K, the fund employs its seasoned research team to invest in large cap European growth companies that are good corporate citizens.
TIAA-CREF Social Choice Equity Mutual Fund, launched in April, comes from the largest pension fund organization in the U.S with $288 billion in assets. This fund has already been available to pension members for 10 years, and has $4 billion assets, making it the largest social fund in existence.
Citizens Small Cap Index Fund is the first passively-managed small cap fund to grace the world of social investing. Launched in December 1999, this fund invests in the same 300 companies that comprise Citizens' new index by the same name, chosen using the same rigorous social and environmental screens as the other five funds in this $1.4 billion family.
Walden/BBT International Social Index Fund is the first socially responsible international index fund, launched in August 1999, focusing on companies in Europe, Australia, and the Far East. Managed by Walden Asset Management's Geeta Aiyer, a leader in international social investment, this international fund is pioneering the engagement of oversees companies on issues of corporate responsibility like human rights and the environment.
This article appeared in the July/August edition of Business Ethics Magazine.