Most socially responsible mutual funds are born of a desire to help the environment, slow the spread of violence or boycott certain practices. Parnassus Workplace (PARWX), on the other hand, sprang from between the covers of Fortune magazine.
Several years ago, Jerome Dodson, who founded Parnassus Investments in 1984, stumbled upon an interesting tidbit: The stocks of publicly traded companies that made Fortune's list of the "100 Best Companies to Work For" tended to perform exceptionally well.
Operating under that premise, Dodson launched Parnassus Workplace in 2005. Since then, the fund, which invests exclusively in companies that treat their employees well, has consistently trounced the competition.
It's also the top-ranked fund in U.S. News' recently unveiled mutual fund rankings. A number of other socially conscious funds join Parnassus Workplace atop the list. Taken together, these funds hint at a shifting landscape for socially responsible investing, or SRI, even as the debate rages on over the wisdom of mixing morality with stock picking.
In the process, the most fundamental of questions often go unanswered: Do social screens harm performance? Under what circumstances will a socially responsible fund outperform the market? And what changes are on the horizon for this style of investing?
A broad range of interests
Broadly defined, socially responsible funds can focus on anything from religion to the environment to pacifism. By style, they can invest in large-cap stocks, small-cap stocks, bonds and anything in between. Given this range, there's no ideal way to track the performance of SRI funds as a group.Still, there are some adequate proxies. A U.S. News analysis of funds classified as socially responsible by Morningstar shows that they lost 32% in 2008 and were up 28.4% in 2009. By comparison, the Standard & Poor's 500 Index ($INX) shed 38.5% of its value in 2008 and rose by 23% in 2009. Meanwhile, the Social Investment Forum, a trade group for SRI investors, found in an analysis of 160 socially responsible funds that 65% outperformed their benchmarks in 2009.
A final way to quantify the performance of SRI funds is through measures such as the FTSE KLD 400 Social Index, which tracks the returns of stocks that are attractive to investors concerned about environmental, social (excluding religious) and governance issues. The index has one-, three- and five-year returns that beat the S&P 500.
At the same time, there are a number of far less positive indicators for SRI funds. Alternative-energy funds, for instance, got crushed in 2008 and generally didn't rebound nearly enough last year to erase the damage.
David Kathman, a Morningstar analyst who covers SRI funds, often gets asked whether they are capable of beating the market.
"They certainly can (outperform), because there are some that have really good records," he says. "The question is whether that's despite their social screening or because of it or just not directly related to it."
Too many restrictions?
Common wisdom holds that the more restrictions a fund has, the more difficult it is for it to consistently perform well. By that measure, SRI funds, which aim to screen out not only financially unsound investments but also investments that are socially or ethically objectionable, start at somewhat of a disadvantage."There are certainly investments that could generate a strong financial return that we've taken a pass on," concedes Adam Strauss, a co-manager of the Appleseed Fund (APPLX), which avoids companies in the tobacco, alcohol, pornography, gambling and weapons industries.
Still, the Appleseed Fund gained 60% last year after losing just 18% in 2008. In many ways, Appleseed represents the traditional model for a successful SRI fund: It has delivered superior results despite, but certainly not because of, its screens.
But increasingly, there are signs that a new generation of SRI funds is emerging, one that thinks of screens not as a net neutral or even as a potential hindrance but instead as a successful investing strategy. This new strain is perhaps most evident in the environmental arena, where the combination of innovation and a softening of public opinion has paved the way for funds to benefit from their focus on green investing. A recent survey by Allianz Global Investors, for instance, found that 71% of respondents see environmental technology as the next great U.S. industry.
Then there are funds like Parnassus Workplace. On its surface, the fund's concern for strong workplace environments appears to be exclusively ethical. But in reality, Dodson's decision to invest only in those companies that provide superior conditions for workers is much like the choice a manager would make to buy a stock only if it's trading at a certain valuation. In other words, it's a self-imposed restriction, but one that is ultimately aimed at making money.
"If you have a happy work force -- people that like the company, that feel they're being treated fairly -- I think they're going to work harder," Dodson says. "And in today's economy . . . you really need a motivated work force."
It goes without saying that most large-cap funds, regardless of the talent of their management, will get a boost when blue chips rally. Meanwhile, if big-name stocks fall out of favor, there is little that a large-cap fund can do to buck the trend. The same goes for sector funds when a given type of investment is either rising or falling.
