Socially responsible investment is booming, with the total dollars under management by U.S. funds specializing in this strategy more than quadrupling, from $639 billion to $2.7 trillion, between 1995 and 2007. But how has this ethically enhanced approach to investing fared in terms of market returns?
Of late, not so hot. Although the stock prices of publicly held companies identified as socially responsible are up in 2009, over the last three years they show an average annualized return of -5.7 percent, according to index data from KLD Research & Analytics. The following table charts the performance of different baskets of U.S. equities that meet a range of social, environmental, faith-based and other standards (click to expand).
These poor returns are no surprise, given the state of the markets since 2008, and obviously aren't confined to socially responsible companies. More notably, businesses that get high marks for their corporate governance, environmental, diversity and other policies have over the years matched, and even marginally exceeded, the returns of other companies. KLD's Domini Social Index 400 has slightly shaded the S&P 500 for the last decade or so (click on chart to expand). The performance of socially responsible investments also varies considerably according to their philosophy, whether it's to favor companies with strong labor relations or those that, say, support Catholic doctrine.
For now, SRI remains a niche, but rapidly growing, market. As of 2008, worldwide investments in the sector amounted to roughly $5 trillion, only seven percent of total assets under management. In the U.S., the largest SRI market with $2.7 trillion under management, roughly 11 percent of investment targets such companies, compared with 17 percent in Europe. The strategy is most popular in the U.K., where 20 percent of total funds under management are involved in SRI. Since 2003, the SRI market has grown 22 percent annually, a far higher clip than for conventional investments.
Some SRI funds are doing exceptionally well. Appleseed, a no-load U.S. mutual fund with $27 million in assets, has a trailing one-year return of 9.4%, far outpacing the S&P 500. The fund, whose equity holdings include pharmaceuticals such as Pfizer, health care giants such as Johnson & Johnson and tech plays such as Teradata, refuses to invest in tobacco, alcohol, pornography, gambling or weapons companies.
Appleseed's longer-term performance is equally strong, powered recently by a rebound in the markets. Since launching in late 2006, the fund has a return of roughly 10 percent, compared with the S&P 500's return over that period of -24 percent.
The standard knock on SRI is that investors might have to shun the best-performing stocks and can't seek refuge in certain equities, like defense industry stocks, that may offer shelter in periods of high market volatility. They may do "good," in other words, without doing "well."
Recent academic research confirms this disadvantage. Indeed, some studies show that stocks of companies in 'sin' industries, such as booze and tobacco, typically net higher returns than those of companies in other sectors. Interestingly, however, the lower returns funds generate by avoiding certain stocks appear to be offset by the higher overall market performance of socially responsible companies.
Take this recent joint study by researchers at Santa Clara University and Barclays Global Investors, who reviewed 15 years of stock returns of socially responsible companies. Stocks of companies rated as very socially responsible yielded higher returns than stocks of companies that fare poorly on such measures, the authors concluded. They also said that investors who want their portfolios to reflect their values should use a best-in-class approach to stock-picking. That means putting money into socially responsible companies, while refusing to shun the stocks of any individual business, such as tobacco companies.
The upshot? Over the long haul, socially responsible and conventional approaches to investment do about equally well. The lower returns resulting from screening out certain stocks are balanced by the higher returns produced by using some social responsibility criteria. Let your conscience dictate.