'Clean' funds get dirtier -- and better

By Tim Middleton

It's getting easier to invest in line with your ideals.

Mutual funds that call themselves socially responsible are generally poor. Except during the Internet bubble, Domini Social Equity (DSEFX), the movement's benchmark, has consistently lagged the Vanguard 500 Index (VFINX). If you have owned it since Jan. 1, 2000, you're down 8.8%, while Vanguard's index fund has come back to deliver a 3.9% total return.

But social investors are gaining many other opportunities to do well as they do good. Two funds have been so successful they've become the biggest of the group, $4.29 billion Ariel (ARGFX, news, msgs) and $2.73 billion Ariel Appreciation (CAAPX, news, msgs).

And in recent years a host of new funds have been introduced, most recently PowerShares Cleantech Portfolio (PZD, news, msgs), an exchange-traded fund that shuns pollution and excessive energy consumption. It joins PowerShares WilderHill Energy (PBW, news, msgs), which is ahead 11.1% this year, as of Oct. 25, well ahead of Domini's 9.6% gain.

Socially responsible investing, or SRI, is likely to get a further boost as it matures and its priorities change. It is becoming more tolerant of former shibboleths like alcohol and defense. It is also broadening its scope to include sector and international funds, and is producing more top-flight performers.

The changes are coming in response to shareholder demands that their movement keep pace with the times, both socially and economically.

Repealing prohibition

Most recently, the Pax World family of SRI funds abandoned its total opposition to liquor, one of the traditional sins the movement opposed. It acted because it had been forced to sell a favorite name, Starbucks (SBUX, news, msgs), when Starbucks did a deal with Jim Beam to produce a coffee liqueur.

Separately, Calvert Group abandoned its ban on weapons stocks. Defense is a hot-button issue in SRI, which traces its roots to the anti-Vietnam War movement. Calvert acted to give managers more flexibility to choose, for example, to invest in companies whose products, like armor plating, are used by U.N. peacekeepers.

The changes are coming in response to the changing views of SRI investors, says Timothy Smith, president of the Social Investment Forum, an umbrella group. "When you ask people if they want to invest in and make profits from (sin stocks), they'll say, 'No, but that's not like climate change. That's my No. 1 issue,' " he says.

Another issue is closing the performance gap between SRI funds and their apolitical rivals. "A lot of individuals are very concerned about social and governmental and environmental issues, but they'll also say, 'I'm setting aside this money for my retirement, and I can't afford to underperform significantly,' " Smith says.

Underperformance has been SRI's bane. Domini Social Equity, which screens out whole swaths of the economy from liquor to gaming, has lagged the Vanguard 500 since its inception in 1991, except for in 1998 and 1999.

Clean and mean

Many of SRI's best-known names are performance weaklings. Dreyfus Premier Third Century Z (DRTHX) has done worse than 86% of similar funds over the past 15 years, according to Morningstar. Parnassas Fund (PARNX) has been beaten by 82% of similar rivals over the past five years.

A few stalwarts have defied this malaise. Amana Trust Growth (AMAGX), which uses moral screens based on Islamic precepts, has beaten the market by an average of more than 6 percentage points in each of the past five years.

Calvert Large Cap Growth A (CLGAX), which uses social screens, has bettered the market by nearly 3 points over each of the past five years, despite being burdened with a 4.75% front-end sales charge and a very high (for its size) 1.5% expense ratio.

And they are not singular exceptions. A growing number of SRI portfolios are joining the winners' camp:

• Ariel Funds combine social goals like community investment with a value approach to securities in general. Ariel fund, whose five-year performance advantage over the market is 5 points, holds a big stake in insurer Markel (MKL, news, msgs).

• Winslow Green Growth (WGGFX, news, msgs) has racked up annualized gains of 14.9% over the five years ended Oct. 25 with an emphasis on environmentally friendly companies like Whole Foods Market (WFMI, news, msgs).

• GuideStone Funds, which claims to be the largest Christian fund family, has delivered annualized five-year returns of 15.2% at GuideStone Funds International Equity GS2 (GIEYX). A top holding: oil giant Total (TOT, news, msgs).

• The PowerShares funds, Cleantech and WilderHill, target specific market niches attractive to greens. WilderHills' top position is Emcore (EMKR, news, msgs), a maker of communications equipment, including solar cells and panels.

An uneasy meeting point

Socially responsible investing has always represented an uneasy meeting point between idealists and capitalists. In addition to climate change, a top concern of the SRI movement is free trade, which it opposes.

"One of our leading priorities is the whole issue around sweatshops and child labor and the counterbalance to that, which is creating a fair trading system," says Alisa Gravitz, executive director of Co-op America, a grass-roots organization allied with the Social Investment Forum.

Her group promotes SRI in order to gain economic leverage to counter its political weakness. That's the tactic such groups successfully used to help eradicate apartheid in South Africa, overwhelming politicians' indifference.

"We focus on the economic strategies, and some of the unique things we can do through that leverage you can't do through other leverages," Gravitz says. One of SRI's most powerful new tools is shareholder activism, and it won enormous clout when the Securities and Exchange Commission ordered mutual funds to disclose how they vote their shares, thus enabling activists to lobby them as well as the companies themselves.

The most despised company in the SRI world is Altria Group (MO, news, msgs), the cigarette giant. Yet the largest single shareholder of Altria is Capital Research & Management, operator of the American family of funds, the most successful in the industry.

As a matter of fact, Altria's top shareholders also happen to be the cream of the mutual-fund industry, from Vanguard Group and Wellington Management to Fidelity Investments and Davis Selected Advisers.

But if you prefer to put your prejudices ahead of your pocketbook, at least you have more opportunities to do so without getting skinned. And as Pax World's change of heart over Starbucks shows, sometimes in the clash between capitalism and idealism, capitalism wins.

At the time of publication, Timothy Middleton didn't own any securities mentioned in this article.