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Find the Right Socially Responsible Fund

David Kathman, CFA

Socially responsible investing, or SRI, which avoids or favors certain investments for moral or ethical reasons, has become big business, with an increasingly wide range of options for investors. There are currently around 100 U.S.-based socially responsible mutual funds in Morningstar's database, and that doesn't include a similar number of religiously oriented mutual funds, which screen their portfolios according to religious principles. All these choices can make it tough to sort through all the options, especially since SRI funds can vary quite a bit in the screening criteria they use.

Back in 2007, we surveyed the landscape of religious mutual funds and nonreligious SRI funds. While the broad outlines have remained the same, quite a bit has changed since then, with new funds being launched and others being merged away or liquidated. A little more than a year ago we took an updated look at religious funds, and now it's time for another survey of the secular SRI fund universe.

Socially Responsible Fund Shops
Many of the best-known SRI funds come from shops that specialize in socially responsible investing (also known as ESG investing, for "environmental, social, governance") and make it a central part of their mission. Several of these shops have multiple funds from various asset classes, making it possible to build a diversified socially conscious portfolio. Not only do these fund companies use thorough social screens (both positive and negative), they typically also use shareholder activism and other means to more actively influence companies and invest in nonprofits and other nonpublic companies that promote positive values.

A good example of this type of fund shop is Calvert. Although it does sell several bond funds without social screens, Calvert offers a diverse lineup of more than a dozen different SRI funds, the oldest of which, Calvert Equity (CSIEX) and Calvert Bond (CSIBX), were launched in 1987. Most of these funds use social screens that eliminate alcohol, tobacco, gambling, and weapons stocks while favoring such factors as good environmental records and labor practices. The firm also has three funds (Calvert Emerging Markets Equity (CVMAX), Global Alternative Energy (CGAEX), and Global Water (CFWAX)) with more-specialized mandates and less emphasis on screening per se. All of these funds use shareholder advocacy (letter writing, proxy voting, resolutions) in an effort to influence corporate behavior, and this is a particular focus in Calvert Equity Income (CEIAX) and Large Cap Value (CLVAX), which can own companies that don't meet the screening criteria but have the potential to improve. Calvert also uses "social venture capital" to invest in early-stage companies that help solve social problems, and it invests in a nonprofit foundation that promotes community development through such means as small-business loans and microcredit. (More details are available here.)

The other major SRI shops employ similarly wide-ranging methods. The largest individual SRI fund is Parnassus Equity Income (PRBLX), which has more than $8 billion in assets and a Morningstar Analyst Rating of Silver. It's one of six funds run by Parnassus Investments, which screens out companies involved with alcohol, tobacco, gambling, weapons, nuclear power, or having business dealings with Sudan. It also favors companies with positive ESG features and does shareholder activism and community investment. (You can read more here.) Other major SRI shops include Domini, whose three funds include Neutral-rated Domini Social Equity (DSEFX); Pax World, whose six funds include the $2 billion Pax World Balanced (PAXWX); and Walden, whose five funds include three focused on small- and mid-cap stocks. (Pax World is also the advisor to the four ESG Managers funds, which it runs in conjunction with Morningstar Associates, a unit of Morningstar Inc.'s investment Management group.) All of these shops have funds in various asset classes; each uses similar social screens, both negative and positive; and each actively uses shareholder advocacy and community development to promote its goals. For example, Walden has supported such community development projects as the Calvert Community Investment Note and Boston Community Loan Fund.

There are also a few smaller socially responsible shops with only one or two funds. They include the Bronze-rated Appleseed (APPLX), whose big gold stake caused it to trail its peers badly in 2013 despite a solid long-term record; the Boston Common funds (International (BCAIX) and US Equity (BCAMX)), both launched since 2010; and several of the alternative energy funds discussed below. One of the more interesting funds in this group is Eventide Gilead (ETGLX), which sports a 5-star Morningstar rating and has gathered nearly $400 million in assets since its 2008 launch. It combines secular and religious screening; manager Finny Kuruvilla screens the portfolio according to five broad principles that encompass many traditional SRI screens (environmental stewardship, avoiding alcohol, tobacco, gambling, and pornography), but which also has a biblical basis that leads the fund to avoid abortion-related stocks, among other things. Kuruvilla also runs Eventide Healthcare & Life Sciences (ETNHX), which uses the same screening criteria but focuses on health care.

Broad-Based SRI Funds From Other Shops
In addition to these shops devoted exclusively to socially responsible investing, several other families offer socially responsible funds as part of a broadly diversified fund lineup. These offerings vary quite a bit in their characteristics, but they're not necessarily as focused on SRI/ESG investing as the funds mentioned above, and not all of them do extra things featured in the SRI-only shops, such as community investment. They can be a good option if you'd like to keep your investments in a single fund family and want a socially conscious option; some of these funds also carry relatively low expense ratios, another big plus.

Some of these are index funds, which generally do use fairly strict social screens. Vanguard FTSE Social Index (VFTSX) tracks the FTSE4Good U.S. Select Index; its 0.28% expense ratio makes it one of the cheapest SRI funds around and helps earn it a Morningstar Analyst Rating of Bronze. Until December 2005, this fund tracked the Calvert Social Index, which is still available to investors through the more-expensive Calvert Social Index (CSXAX). Northern Global Sustainability Index (NSRIX) tracks the MSCI World ESG Index. Bronze-rated TIAA-CREF Social Choice Equity (TISCX) is a sort of indexlike fund that aims to replicate the risk characteristics of the Russell 3000 index while also subject to the social screens maintained by the social-investment department at MSCI. There are also a handful of socially responsible exchange-traded funds that use MSCI indexes: iShares MSCI KLD 400 Social (DSI), iShares MSCI USA ESG Select (KLD), and Pax MSCI EAFE ESG Index ETF (EAPS), the latter of which holds foreign stocks. The only other broad-based socially responsible ETF is AdvisorShares Global Echo ETF (GIVE), which is actively managed and thus doesn't follow an index.

Quant shop DFA has seven SRI funds in its lineup, four that hold international stocks (of which the largest is DFA Emerging Markets Social Core Equity (DFESX)) and three that hold domestic stocks (of which the largest is DFA US Social Core Equity 2 (DFUEX)). Like the other DFA funds, these are not index funds, but their portfolios are determined by quantitative models favoring factors that have been shown to outperform over time, with the addition of social screens that differ from fund to fund.

Actively managed SRI mutual funds from large diversified fund shops include Neuberger Berman Socially Responsive (NBSRX), Dreyfus Third Century (DRTHX), Sentinel Sustainable Core Opportunities (MYPVX) and Sustainable Mid Cap Opportunities (WAEGX), VALIC Company II Socially Responsible (VCSRX) and Company I Global Social Awareness (VCSOX) (sold only to retirement plans), Gabelli SRI (SRIAX), and Legg Mason Investment Counsel Socially Aware (SSIAX). Of these, the Neuberger fund is the most attractive, sporting a Morningstar Analyst Rating of Silver, largely because it's a near-clone of the Silver-rated Neuberger Berman Guardian (NGUAX). The social screens used by manager Arthur Moretti are somewhat subjective, and the two portfolios only differ in a few stocks, though it's hard to argue with the results. The two Sentinel funds use fairly standard social screens and are the only remnants of the Citizens funds, an SRI shop that Sentinel bought in 2008.

A further group might be called "SRI Lite," which have only a few restrictions based on social screens, sometimes just one or two. For example, the nine American Century NT funds, the largest of which is American Century NT Large Company Value (ACLLX), are near-clones of other funds (in this case, American Century Large Company Value (ALPAX)), the only difference being that the NT funds cannot own tobacco stocks. Despite that restriction, it would be a stretch to call these socially responsible funds in the usual sense. Invesco Summit (SMMIX) isn't allowed to hold tobacco or gambling stocks; Wells Fargo Advantage Large Cap Core (EGOAX) doesn't hold alcohol, tobacco, or gambling stocks; and Ariel (ARGFX) and Ariel Appreciation (CAAPX) aren't allowed to hold tobacco, nuclear power, or handgun stocks. None of these are usually thought of as SRI funds, though Ariel manager John Rogers generally prefers companies that are environmentally friendly and have diverse workplaces, and Ariel sponsors a number of educational initiatives for economically disadvantaged young people.

Specialty SRI Funds
All of the funds we have seen so far use broad social criteria for their screens, but there are also plenty of funds that focus primarily on one issue.

The largest such group is the "green" funds, which place priority on environmental issues. Such issues are often a factor in the funds we have seen above, but here they take center stage and are more strictly adhered to. For example, Green Century Balanced (GCBLX), subadvised by Trillium Asset Management, only invests in stocks that "strive to maximize their environmental advantages and minimize their environmental risks" and looks to invest in green bonds "that support energy efficiency and emissions reductions programs through domestic and international corporations and agencies" (see here for more). (Sibling Green Century Equity (GCEQX) is an index fund that tracks the MSCI KLD 400 Index, which is socially responsible but not specifically green.) Alger Green (SPEGX) and Brown Advisory Sustainable Growth (BAFWX) are diversified funds that similarly invest according to green principles but are part of larger fund shops. Along related lines, there are now many funds that invest primarily in alternative energy and similar stocks. These include New Alternatives (NALFX) and Portfolio 21 Global Equity (PORTX), both of which invest heavily overseas and are in the world-stock category, as well as Fidelity Select Environment and Alternative Energy (FSLEX), Firsthand Alternative Energy (ALTEX), Guinness Atkinson Alternative Energy (GAAEX), Shelton Green Alpha (NEXTX), and more than a dozen exchange-traded funds, including PowerShares WilderHill Clean Energy (PBW) and Guggenheim Solar (TAN). Several ETFs also focus on water infrastructure, the largest of which is the $1 billion PowerShares Water Resources (PHO).

The remaining specialty SRI funds focus on a variety of issues. CRA Qualified Investment (CRAIX) invests in fixed-income securities that qualify under the Community Reinvestment Act, meaning they're primarily used for community development. It's the largest fund in this group, with more than $1.5 billion in assets, though most of that is from banks and similar institutional clients. Access Capital Community Investment (ACCSX) invests in bonds that support the affordable housing industry, while Delaware Pooled Labor Select International Equities (DELPX) invests in foreign stocks that operate in accordance with policies and restrictions followed by organized labor and that haven't been penalized for unfair trade practices within the past two years. A couple of the SRI-only shops we saw above have specialized funds: Parnassus Workplace (PARWX) invests in companies that provide a good workplace for their employees, and Pax World Global Women's Equality (PXWEX) invests in companies that promote gender equality, especially those that embrace the Women's Empowerment Principles of UN Women and the United Nations Global Compact.

The Next Step
This survey has not exhausted all the socially responsible funds out there, but it should give some idea of the variety that's available. As we've noted before, there's no good evidence that SRI funds as a group do any better or worse than other funds over the long term, though in the short term their performance can differ. If you do decide to buy one of these funds, it should be because you agree with the principles behind it and like the way that particular fund implements them. That's why it's especially important to look at an SRI fund's prospectus, and any other materials the fund company may make available, before you invest in such a fund. The Socialfunds.com and US/SIF websites also have resources that can help you find out more about specific funds and generally navigate through the world of SRI investing.

David Kathman, CFA does not own shares in any of the securities mentioned above.