The Long & Short of It
Socially responsible investing (SRI) has been taking a pounding in the mainstream financial media. The Wall Street Journal, Money, and Forbes, to name just a few, have been running columns carrying headlines such as “Good Intentions, Bad Results” and “It’s Not Easy Being Green.” These articles typically portray social investors, who won’t invest in polluting or destructive companies, as good-hearted saps destined to receive lousy returns.
What these authors seem to forget—or choose to ignore—is that just a few years ago those same publications were sprinkled with headlines such as “Doing Well by Doing Good.” While SRI wasn’t endorsed with quite the gusto with which it is now being panned, the typical article would profile successful SRI funds, such as Pax World or Parnassus, and suggest that superior investing returns resulted from using ethical screens.
Not surprisingly, the alternative financial press has never wavered in its support of SRI. Business Ethics, Coop America, and The GreenMoney Journal have run numerous articles reiterating that avoiding unethical companies won’t affect returns. Some SRI backers, such as Dr. Ritchie Lowry, author of Good Money, have even speculated that social screening may improve returns, since most ethical companies are less likely to be sued and tend to be fiscally conservative.
Who’s right? And what’s behind the about-face in mainstream media coverage? Is there some basis for the criticism?
In most investing categories (e.g. bond funds, stock and bond funds, international funds, etc.) SRI mutual funds do as well or better than their unscreened cousins. But when it comes to growth funds (those funds that take on higher risk in an attempt to generate above-average returns) as a group SRI returns have seriously lagged.
Business Ethics’ SRI funds performance chart (with results through March 31) shows the overall average of SRI growth funds producing roughly five percent lower annual returns for both one and three years compared with unscreened growth funds. “The reason for lagging performance is poor fund management,” says Peter Kinder, editor of The Social Investment Almanac and an SRI pioneer.
When asked to explain their results, all the underperforming SRI funds echoed Kinder’s sentiments. They emphatically dismissed social screens as the cause of their troubles. Most blamed either investing style or market timing. That is, either their investing philosophy was out of vogue or they were mostly holding cash when the stock market took off.
One possible explanation for the lagging returns of many SRI growth funds is given by Prentiss Smith, portfolio manager at the $120 million Prentiss Smith & Company—a top-performing SRI money management firm located in Brattleboro, Vermont. Prentiss Smith, who actively invests in tech companies, notes that most SRI funds tend to be underweighted in technology stocks. “As telecommunications and computers become an increasingly large and fast-growing part of our economy, it’s important for any well-diversified and successful portfolio to be appropriately represented with conscientiously chosen technology companies,” says Smith.
The excellent long-term track record of Prentiss Smith and even the Parnassus fund (which has been struggling lately) backs this up. Of the SRI growth group, Parnassus has traditionally had the heaviest weightings in technology. In fact, as a recent SmartMoney profile of Parnassus manager Jerome Dodson points out, part of his recent performance problems can be attributed to selling off technology stocks that he thought “were grossly overvalued.”
Jumping to Conclusions
Still, the question remains: Do disappointing SRI growth fund returns imply an investment handicap? And should socially responsible investors give up on the notion that politics and profits are compatible?
“It’s too small a group to draw performance conclusions. Besides, almost half of the growth funds are less than three years old,” says Lloyd Kurtz, financial analyst at Harris Bretall Sullivan & Smith and regular Business Ethics columnist. “There have been periods when SRI funds or fund categories have outperformed unscreened funds. Does that mean we should conclude SRI improves performance? Of course not. In fact, the SRI industry itself is partly to blame for the backlash it’s now receiving because they took the credit earlier for above-average returns.
The most disheartening study of SRI results shows social investors losing about one percentage point of return a year. The recent performance of SRI growth funds far exceeds that handicap, suggesting that it is indeed a statistical aberration.
“All the research I’ve done shows social screens have no effect on performance,” says Kurtz, referring to his in-depth, risk-adjusted analysis of the Domini Social Index, a socially screened index of 400 companies that’s akin to the Standard & Poor’s 500.
A recent study by Santa Clara University professor of finance Meir Statman reached the same conclusion. “Social screening affects investing results as much as screening out companies with left-handed CEO’s,” says Statman.
“You have to be suspicious of anyone who says screening hurts performance, since different funds screen for different criteria,” says Steve Schueth, spokesman for the Calvert funds.
Echoing the position that it is management, not screens, that affects returns, Prentiss Smith points out: “Warren Buffet’s [investor extraordinaire] current portfolio looks like it’s been socially screened.”
The proverbial bottom line is this: If you care about performance as much as consistency of your ethics, make sure the person managing your money isn’t just a good guy/gal, but also a good stockpicker. “It’s a shame when social investors don’t get top returns,” says Prentiss Smith. “Our clients have done some wonderful things—such as supporting land trusts and saving organic farms—with their profits.”
Marshall Glickman is an active insvestor and a former financial consultant for Shearson Lehman Brothers, living in South Newfane, VT. He edits and publishes Green Living, an environmental journal which regularly covers SRI.