By Tom Roseen
Many investors are enamored of the concept of long-term accumulation of wealth. They have drunk from the well of modern portfolio theory and have as their main focus to maximize their portfolios' expected return given a particular amount of portfolio risk. However, some investors not only expect a reasonable return on their portfolios, they also want their investments to reflect their social, political, or religious expectations and beliefs.
The concept of socially responsible investing (SRI) in the U.S. can be traced back to the colonial era, when some religious groups-particularly the Methodist Church and later on the Religious Society of Friends (the Quakers)-refused to invest their funds in the slave trade. But it wasn't until the 1920s that SRI took a specific form: an ecclesiastical group created the first publicly available investment fund (Pioneer Fund) to screen out tobacco, alcohol, and gambling investments. Until the late 1960s most SRI funds focused on avoiding "sin" stocks. Then the SRI movement began supporting the civil rights, environmental, social, and anti-war movements. While security, sector, or regional avoidance was still the primary SRI strategy, the subject guidelines became much broader.
Since then, socially aware practices have continued to evolve. While in the beginning virtually all SRI portfolios were constructed using negative screens to avoid investments contrary to defined ethical guidelines, many of these portfolios underperformed their benchmarks. Many "sin" stocks and related industries the portfolios had excluded often did very well during certain market rotations. Even though some investors were willing to accept underperformance from their portfolio so they could sleep well at night, most still wanted a reasonable return.
Today SRI is often referred to as socially conscious, ethical, green, mission, religious, or sustainable investing having strategies that screen out weapons manufacturers, gambling establishments, tobacco companies, abortion-related securities, pornography, etc. or that screen in best-in-class shareholder-friendly companies. Whatever their cause, SRI investors seek two things: reasonable returns and targeting special social causes.
There are three basic methods to select a company for inclusion into an SRI fund. The first, as mentioned earlier, is the negative screen. The second method is the positive screen, where the fund manager chooses companies that engage in a particular activity: corporate social responsibility, development of solar power, promotion of women in the workplace, or some combination of attributes. The third method is a restricted screen in which a manager may select a firm that, because of its diversified structure, might have activities in a less-than-desirable sector, but the rest of the firm's activities are acceptable to the manager. This last method may also include investing in organizations that have a tilt in the right direction, that is, organizations that have made strides to improve their greenhouse gas emissions or that have reduced their dependence on coal.
In recent literature on social investing there are two fairly new terms related to responsible investing. The first is environmental, social, and governance (NASDAQ:ESG) investing, which is not necessarily synonymous with SRI. ESG investing factors the three subjects into fundamental investment analysis to the extent they are considered material to investment performance. ESG investing aims to improve investment performance by searching, with the mission goal in mind, for the best-in-class organizations. There is a growing understanding that certain ESG issues that are not captured in traditional fundamental analysis can prove to be germane to investment performance; for example, when Coca Cola cut its emissions it saved millions of dollars in the process.
The second new term is impact investing, which involves investing in securities, projects, or firms with the stated goal of impacting the portfolio's mission-related social or environmental change. On the mutual fund side Access Capital Community Investment Fund (MUTF:ACASX) is a prime example of an impact investment offering that might not have shown up on SRI screens a few years back because of its one-topic focus: the fund invests primarily in debt securities and other debt instruments supporting the affordable housing industry.
Interest in SRI mutual funds has grown over the last two decades. In 1994 there were only 56 unique funds (ignoring share classes), with combined total net assets (TNA) of just $4.0 billion. By March 31, 2015, those numbers jumped to 186 unique funds with a combined value of $89.9 billion. While assets under management remained relatively subdued, the "stickiness" of the assets and the conviction of SRI fund investors through the market tribulations of the bursting of the tech bubble from 2000-2003 and the 2008 financial crisis were quite amazing. While conventional equity mutual funds witnessed net redemptions for 2002 and 2008, SRI funds witnessed net inflows for both periods. While TNA did decline for SRI funds because of the market losses (-12.88% and -30.59% on average for 2002 and 2008), investors appeared to use those opportunities to buy on the dip. After hitting a low in 2008 the TNA of the group jumped 121% from $40.7 billion to just over $89.9 billion now.
Perhaps as noteworthy is the number of diversified investment options available to investors. In 1994 there were approximately 28 different Lipper classifications from which to choose socially aware funds. By March 2015 socially aware funds were offered in 57 classifications. For the one-year period ended March 31, 2015, 49% (26 of the classifications) of the average returns for SRI/ESG/impact-investing funds beat their non-SRI classification averages. For example, the average one-year return for all Global Equity Income Funds was 1.68%, while the average return for SRI Global Equity Income Funds was 6.39%, a 4.71-percentage-point difference. The SRI average consisted of the two share classes of the same fund: Steward Global Equity Income Fund (MUTF:SGIDX), so our comparison is a little apple to oranges. Nonetheless, and in contradiction to what many pundits have hypothesized, SRI funds don't always underperform their category averages or their underlying benchmarks. In fact, all five top-performing SRI funds shown in the table below handsomely beat their broad-based classification averages for most of the periods.
Source: Lipper, a Thomson Reuters company
Despite the relative increase in number of offering of SRI funds, clients are still finding it difficult to find advisors who are knowledgeable of SRI/ESG/Impact investing. BlackRock, Merrill Lynch, and other key money managers are stepping up their games to add value-based strategies and develop new products. However, with a little research, advisors can find funds that fit their clients' needs with excellent track records.
At 2015 Lipper Funds Award, on March 31, two ESG/impact investing funds and two faith based funds took home Lipper Fund Awards, for their best in class risk-adjusted performance within their peer groups over the three- and five-year time periods ended November 30, 2014. Calvert Global Water Funds (MUTF:CFWAX), Y Shares (MUTF:CFWYX), posted the strongest risk-adjusted return of all qualifying Global Natural Resources funds for the 3-year period; Parnassus Core Equity Income Fund (MUTF:PRBLX), Institutional Shares (MUTF:PRILX), won the Lipper Fund Award for the best Equity Income Fund at the 3-year mark; and Steward Global Equity Income Funds (SGIDX), Institutional Shares (MUTF:SGISX), was crowned the winner for the strongest risk-adjusted returns for the 5-year time period of all Global Equity Income Funds. Another fund in the faith-based group, GuideStone Extended Duration Bond Fund (MUTF:GEDZX), Institutional Shares (MUTF:GEDYX), for the second consecutive year, won the Lipper Funds Awards for both the 3-year and 5-year time periods for Lipper's Corporate Debt A-Rated Funds classification.
Perhaps as telling that SRI Funds are worthy of mainstream attention, is the knowledge that out of 38 qualifying fund management companies faith-based Thrivent Asset Management won Lipper's Best Small Company Mixed Asset- Funds group award for 2015.
While conventional wisdom might suggest investors are best served by separating their ethical and religious beliefs from their investments, with the new focus on impact and ESG investing investors just may be able to have their cake and eat it too. After all, what is so bad about respecting one's religious, ethical, and/or ecological beliefs while investing? In fact, one might argue that chasing the performance of companies whose managers think only of short-term profits might be more detrimental to one's long-term financial well-being. Perhaps in the future a shift in good business practice away from a short-term profit focus will become the norm for investment analysis. Until that time SRI mutual funds offer investors a simple way to both earn a return on their investments and to support their specific social beliefs.