Once a financial backwater, socially responsible investing is now a virtual tidal wave. Over the four-year period that ended in 2016, the amount invested in the U.S. using professional management that considers environmental, social and corporate-governance issues—ESG, for short—grew from $1.4 trillion to $8.1 trillion. About one-fifth of all assets under management in the U.S. now include some ESG component, according to the Forum for Sustainable and Responsible Investment, and some 500 mutual and exchange-traded funds now practice some form of socially conscious investing.
Calvert Research and Management, which got started in SRI in 1976 with a portfolio that avoided companies that were doing business in apartheid-era South Africa, now has 26 funds, including such specialty products as Calvert Global Water A (symbol CFWAX). Pax World was cofounded in 1971 by a United Methodist official to “allow churches to invest their money in harmony with their message” and now has 11 funds. Among them is Pax Ellevate Global Women’s Index (PXWEX), which gives greater weighting in its portfolio to companies with high female representation on corporate boards and in management. One of the largest ESG-oriented ETFs is iShares MSCI ACWI Low Carbon Target ETF (CRBN, $108), which invests in companies all over the world with low carbon emissions.
Even Fidelity has gotten into the act. This year, it launched its first SRI funds: Fidelity U.S. Sustainability Index (FENSX) and Fidelity International Sustainability Index (FNIYX). They are designed to track two MSCI indexes—one for domestic stocks and one for foreign stocks—that meet ESG criteria. And there are many other SRI indexes. The KLD 400 index, created by three SRI pioneers—Peter Kinder, Steve Lydenberg and Amy Domini—was the basis of much SRI investing in the early decades. It was taken over in 2010 by MSCI; funds that track its indexes have attracted $58 billion in investments. S&P Dow Jones, Calvert, Vanguard FTSE and many others have their own indexes.
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Growing complexity. The notion that investors want to put their money in companies that operate in accordance with certain social or environmental ideals is a positive, even touching, development, but what was once simple has become complicated. In the past, SRI meant merely avoiding companies deemed to be in “evil” businesses; now, companies that score high on often-squishy ESG criteria dominate portfolios.
Regardless of criteria, the big question is whether you must sacrifice return for virtue. In theory, the answer should be yes. Imagine you are a fund manager whose job is to pick the best 100 stocks for your shareholders. You compose your list, and it includes, say, 20 stocks that don’t meet ESG criteria, so you must exclude them. By definition, the stocks that replace the 20 rejects will be inferior. Of course, it could turn out that following ESG principles actually makes companies more profitable. If so, the stocks of those companies should deliver superior returns.
So let’s look at some results. The returns of well-diversified SRI funds trail the broad market, though not by much. Standard & Poor’s 500-stock index, the primary benchmark for large-capitalization U.S. stocks, returned an annualized 14.6% for the five-year period that ended June 30. By comparison, Calvert Equity Portfolio A (CSIEX), one of the largest SRI funds, with $2.1 billion in assets, returned 12.9% annualized; the fund’s annual expense ratio of 1.09% accounted for most of the difference. The big winner among SRI index funds was Vanguard FTSE Social Index (VFTSX), with an expense ratio of just 0.22%. Over five years, it returned 16.4% annualized, beating the S&P 500 by an impressive 1.8 percentage points per year, on average. (Investments in boldface are those I recommend. Prices are as of June 30, as are returns.)
A study by TIAA Global Asset Management looked at five popular SRI indexes over the 10-year period that ended in December 2015 and found that, on average, they lagged the S&P 500 by 0.3 percentage point per year. Only one (Calvert U.S. Large-Cap Core Responsible) beat the S&P, and it did so by just 0.2 point per year. Volatility was almost precisely the same as that of the S&P 500.
None of this is surprising. Eliminating “evil” does not limit choices much. After all, how many publicly traded pornography companies are there? As for “good” stocks, the list is dominated by the usual suspects. A popular holding in nearly all SRI portfolios is Microsoft (MSFT, $69), typically ranking first (even in Pax Ellevate, the women’s fund). Often seen in the top holdings are Google parent Alphabet (GOOGL, $930), Johnson & Johnson (JNJ, $132) and Procter & Gamble (PG, $87). Rarely found in SRI funds because of controversial labor practices are Apple (AAPL, $144), Amazon.com (AMZN, $968) and Nike (NKE, $59). Also usually excluded are such alleged miscreants as tobacco, oil and casinos.
The best SRI choice is Parnassus Fund (PARNX), the oldest fund in a family founded by Jerry Dodson in 1984 and recently explored in depth by Kiplinger’s senior editor Anne Kates Smith (see Investing With a Conscience). Parnassus returned an annualized 16.7% over the past five years, ranking in the top 6% of its category (funds that focus on large-cap growth stocks). The fund, which charges 0.86% annually, has the usual exclusions and is ESG-sensitive, but its top holdings resemble those of few other SRI funds. Among them are Allergan (AGN, $243), an Ireland-based drugmaker, as well as communications-equipment supplier Motorola Solutions (MSI, $87) and insurer Progressive (PGR, $44). Dodson happens to be a terrific stock picker.
In the end, I am not an SRI enthusiast. I lean toward the view of Milton Friedman, the late Nobel Prize-winning economist, who wrote a famous New York Times article in 1970 headlined, “The Social Responsibility of Business Is to Increase Its Profits.” Friedman argued that companies should stick to their knitting, follow the law and distribute earnings to shareholders, who can make their own choices about how to use the money for what they see as the greater good.
I am also loath to outsource my own social conscience to a fund manager or an index compiler. Few ESG indexes have principles that match my own. For example, I think energy companies have contributed to the general welfare by investing billions to extract relatively clean natural gas through fracking. And I have no problem with casinos.
The vagueness of SRI buzzwords is also troubling. I can understand categories such as small caps, Asia stocks or high-yield bonds. But what does sustainability actually mean? Barron’s last year came up with a list of the “top 200 sustainable mutual funds,” and, of the 50 that beat the S&P 500, 49 do not even use the term themselves. The article quoted Jack Murphy, of Levin Capital Strategies, who comanages the top performer on Barron’s list, Transamerica Large Cap Value A (TWQAX): “Sustainability? What’s that?”
Finally, by charging high fees, too many socially responsible funds aren’t responsible to investors. Eventide Gilead N (ETGLX), which is geared toward religious investors, attracted broad attention for whipping the S&P 500 by nearly 21 percentage points in 2013, but it has an excessive expense ratio of 1.39%. Calvert Global Water A has expenses of 1.63%, not to mention a 4.75% sales charge. Exchange-traded iShares MSCI KLD 400 Social (DSI, $89) charges 0.50%—too much for an index fund. The best way to go: Buy one of the Parnassus funds or a low-fee SRI index fund, such as Vanguard’s. Or just confine your socially conscious investing to individual stocks.
James K. Glassman, a visiting fellow at the American Enterprise Institute, is the author, most recently, of Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. Of stocks cited here, he owns Amazon.com.
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