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By: Kevin P. Ross, Vice President
For many investors, there's more to choosing a mutual fund than evaluating its past performance and potential appreciation. They also want to make sure that the companies in the fund's portfolio reflect their personal values.
Some investors may not want to support businesses that sell tobacco or weapons. Others may only want to invest in corporations that have good labor practices and progressive hiring policies. Still others may refuse to buy stock in companies that pollute the environment.
Whatever issues may be important to investors, they can choose from a host of different socially responsible mutual funds that use specific ethical criteria.
However, investing according to one's conscience does require a little more work. The trick is finding a fund that matches both one's investment needs and social concerns.
While most socially responsible funds apply broad social principles, funds can vary as widely in their social criteria as the individuals who invest in them. Investors can find funds that address everything from alcohol to animal testing, gambling to pornography, product safety to discrimination. Some are even based on religious beliefs.
Most socially responsible mutual funds focus on four specific areas: community, environment, employees, and diversity.
However, almost all of these mutual funds use at least one of two methods for investing responsibly. They either screen out companies that are objectionable according to their criteria or participate in shareholder advocacy to try to change corporate practices from within. Sometimes, they do a combination of both.
Most socially responsible funds tend to emphasize larger growth companies for two reasons. One, it's easier to research the practices of large companies. Two, companies in traditional growth sectors, like health-care and technology, tend to pass most screens because they usually make efforts not to pollute and often have good hiring and workplace practices.
This focus on large growth means that socially responsible investors need to look harder to find the right investments to properly diversify their portfolios. However, in most cases, investors should be able to find the necessary market cap and style diversification as well as fixed income that they need in the socially responsible fund universe.
A common misconception about socially responsible investing is that using social criteria to evaluate companies will limit returns. But that isn't necessarily true.
Investors should be aware of the sell discipline of the fund. A fund should sell a stock if the risk/reward characteristics of a stock turn negative, company fundamentals deteriorate, the stock achieves its target price, or the company violates the fund's social criteria.
It's hard to point to their performance as a group because they can include all different styles and market caps. But, relative to their peers, these funds have had roughly average returns. Many socially responsible funds have proven they can be competitive.
Another thing investors should keep in mind is that socially responsible funds tend to be more expensive because they must conduct additional research using both financial and social criteria. Investors should factor a fund's expense ratio into its returns.
However, if an investor is only concerned about performance, there's no reason to invest in socially responsible funds. Even if the decision to invest is based primarily on ethical reasons, the funds should still be evaluated with the same scrutiny applied to other investments. That is, investors should consider the fund's past performance and managerial experience as well as how it fits into their overall portfolio.
Does it make a difference?
Many believe that socially responsible investing can have an effect on large corporations and change the way they do business.
Socially responsible mutual funds for individual investors were first launched in the 1970s because of increased social consciousness about many issues. The demise of apartheid in South Africa in the 1980s is a frequently cited example of how socially responsible investing can work, as many companies were pressured by shareholders to stop doing business there.
Today, there are many less dramatic examples of how companies are realizing that social responsibility can make great financial sense.
For many investors, the possibility of changing corporate practices for the betterment of others makes socially responsible investing very appealing. But individuals must always keep in mind that these mutual funds are investments and should be evaluated accordingly.
While ethical considerations may be the primary reason an investor buys socially responsible mutual funds, it is crucial to make sure the fund makes equal sense from an investment standpoint. In order to construct a profitable portfolio, performance and diversification should be given equal weight to social concerns.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.