Socially Responsible Mutual Funds: Sustainable Investments or Passing Fad?
A growing number of investors these days include ethical concerns when choosing securities for their portfolios. The number of socially responsible mutual funds is growing in response. One of the most exciting things about sustainable, responsible investing (SRI) is that you don't have to give up good performance. Socially responsible funds do about as well as other mutual funds. Some do better.
What Are Socially Responsible Mutual Funds?
Go back in time to the 1990s. A few mutual funds screened investments based on ethical values. Some funds excluded so-called "sin stocks," which usually meant companies involved in the alcohol, gambling, tobacco or weapons industries.
Most socially responsible mutual funds now look at a wider range of issues, including:
- The environmental impact of company products and policy
- Human rights when investing in other countries
- Product safety
- Worker's rights and job safety
- Community involvement in low-income areas
- Corporate governance
Writing in Forbes, Janet Brown says 20 years ago socially responsible funds appealed to people who had strong moral concerns. These funds often provided low returns compared with other mutual funds. Customers were willing to trade some profits for the satisfaction of feeling good about their investments.
If nothing had changed, SRI funds would have been a passing fad. But things have changed.
Environmental, Social and Governance
In 2015, the landscape for socially responsible investing has improved. You don't need to accept low returns.
Hundreds of funds screen investments. That gives you a wide choice and a good probability that you can find funds that offer good returns. Most funds use a mix of environmental, social and corporate governance standards (ESG). Instead of just excluding sin stocks, fund managers seek out firms that make positive contributions.
For example, ESG managers look at the impact of a company's policies and products on the environment. Some ESG mutual funds set aside money to invest in community projects in low-income areas in the United States or in developing nations.
Diversity is another change that benefits SRI investors today. You can choose equity funds for growth. If you want income, go with ESG bond funds. ESG mutual funds of all types are available. Here are some examples:
- Growth funds mainly buy stocks with growth potential and seek to increase the value of the fund shares.
- Index funds select a mix of stocks that matches a market index such as the Standard & Poor's 500. The goal is to match market performance.
- Value funds target value investors. A value fund manager examines each company and looks for solid fundamentals that show a firm has long-term growth potential.
- Small to Large-Cap funds vary. Some ESG funds specialize in small companies. Others buy stocks or bonds issued by medium-sized or large firms. Small-cap funds usually focus on high growth. A large-cap fund takes fewer risks since it invests in well-established firms. The large-cap fund usually achieves more modest gains than a successful small-cap fund.
- Domestic and Global funds also vary. Some invest in U.S.-based corporations. Others specialize in foreign stocks. Still other ESG funds search for good companies in emerging nations that meet screening standards.
- Sector funds invest in a single industry or market sector, such as renewable energy.
ESG funds use the clout of mutual funds to vote for socially responsible policies, write letters and submit proposals. These funds take an active role in corporate governance — in the management policies and philosophy of a company.
If you want to be a socially responsible investor, this turns out to be very important. In a 2012 study, Mark Fulton, et al., discovered that companies meeting ESG governance standards produced higher profits and stock gains.
The authors also found that SRI mutual funds and exchange-traded funds that only excluded "bad" companies usually did no better than match the performance of traditional funds. The socially responsible investor should place first priority on the issue for corporate governance. Environmental and social issues should have lower priority.
A Look Ahead
ESG funds are affected by the same economic and market forces as any other fund. The outlook is pretty good, at least for domestic stocks, according to Charles Schwab. U.S. economic and job growth were strong in 2014.
(The story in other countries may be different — many are struggling to avoid a recession.)
Falling oil prices may help keep inflation low. Plus, low oil prices mean consumers have more money to spend on other goods and services. That helps stimulate the economy. All in all, stock should do well in 2015.
For investors seeking income more than equity growth, the bond market may be mixed. The Federal Reserve is likely to raise interest rates. This may boost interest income. But it might put downward pressure on bond prices. Schwab thinks high-grade bonds will do well overall.
Picking Socially Responsible Funds
The same standards for picking a socially responsible mutual fund are the same for any fund:
- Read the fund prospectus.
- Pay attention to the fund's past performance.
- Know the fees, especially for ESG funds. They do more research and must pass the cost onto investors.
- Look at the fund manager's track record.
Think about diversifying by buying more than one fund, and pick different kinds of funds. For example, you might balance the risk of a small-cap growth fund with a bond fund.
The single most important thing to take away from a study of ESG funds is the impact of corporate governance. The correlation is simple. An ESG fund that takes an active role in advocating for good company practices tends to outperform other funds.