Sustainable, responsible and impact investing — often called socially responsible investing, or SRI — has gained popularity in recent years as investors weigh environmental, social and corporate governance criteria when choosing where to invest.
According to a March Morgan Stanley report on sustainable investment strategies, $1 out of every $6 under professional management was directed into some form of socially responsible investment in 2014, up from $1 out of every $9 in 2012. The analysis included institutional investments that apply various environmental, social and governance criteria in their investment analysis and portfolio selection. Morgan Stanley contends that “sustainability investing has usually met and often exceeded the performance of comparable traditional investments.”
The investment conglomerate’s MSCI KLD 400 Social Index, for example, has outperformed the S&P 500 (^GSPC) consistently over the 25 years since its inception:
Indexes, however, track a basket of company stocks and don’t factor in investing costs such as expense ratios and commissions, which necessarily reduce net returns and tend to be higher for actively-managed funds.
Roughly half of all socially responsible funds ranked in the top 50th percentile for trailing three-, five- and seven-year returns in their respective category, according to Morningstar data — which means the other half didn’t. In the large-cap value category, just 33 percent of SRI funds placed in the top half.
“Over longer periods of time, there really isn’t any good evidence [that] those fund groups either outperform or underperform [the market],” says David Kathman, a senior analyst at Morningstar (MORN), who covers SRI funds. “You’ve got people wanting to believe both, but social screening is not something people should really worry about from a performance perspective.”
Investors should evaluate SRI funds as mutual funds first and as tools for change second, Kathman says. Here are a few factors investors should consider before selecting an SRI fund or strategy over a comparable “traditional” investment.
Evaluate the Costs
There is no lack of research showing that higher investing fees have a negative correlation to performance — and SRI funds aren’t cheap. As with all funds, fees vary and are higher for actively managed ones and lower for passive index funds and ETFs. For example, the Calvert Equity Fund (CSIEX), one of the oldest SRI funds, has an expense ratio of 1.14 percent and an upfront sales charge, or load, of 4.75 percent. TIAA-CREF’s Social Choice Equity fund (TICRX) has an expense ratio of just 0.46 percent with no load.
ETFs are known for having lower fees than mutual funds, but don’t expect rock-bottom costs from SRI ETFs. The iShares MSCI KLD 400 Social ETF (DSI), which tracks the index, which is made up of U.S. companies that have good environmental, social and governance practices, has a 0.50 percent expense ratio. By comparison, the Vanguard S&P 500 ETF (VOO) has an expense ratio of 0.05 percent.
“These are mostly niche funds with modest asset bases, and funds tend to get cheaper as they get bigger,” says Kathman. “Someone might say that the social screening costs more, but I don’t know why that should be more expensive than any other type of research that funds do.”
SRI Strategies Can Be Vague
The traditional way of socially responsible investing is known as negative screening. Investors and funds choose to avoid stocks that might be considered sinful or societally harmful, such as alcohol, gambling, tobacco, firearms and others. This type of socially responsible investing can be traced back to 1928, when the Pioneer Fund (PIODX) was created to enable investors to avoid companies involved in tobacco and alcohol.
Another way to invest responsibly is via positive screening, says Roseen. With positive screening, funds and/or investors pick companies that are doing right by the environment, their employees, their community, and society at large.
The fund managers at the Domini Social Equity Investor Fund (DSEFX), for example, choose companies after looking at their social and environmental practices. Two of the top holdings include Apple (AAPL) and Microsoft (MSFT).
At the same time, according to Kathman, some SRI funds choose to avoid Apple stock because of human rights issues in its supply chain in Chinese factories. So when it comes to selecting which companies to invest in with a social conscious, the decisions aren’t always cut-and-dried.
Invest to Grow Your Wealth
When it comes to SRI investing, investors have to think with their heads, not their hearts. Yes, you want your money to be used for good, but you also want to see it grow, so do your homework first.
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