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
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
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
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
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
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.)