Socially Responsible Mutual Funds

Some investors are comfortable with the idea that unscrupulous means are sometimes necessary for making gains in a portfolio. However, it is possible to profit while using an ethical investment strategy—and you don’t need to join Greenpeace to do so.

As more investors demand socially responsible investing (SRI) options, we’ll take a look at SRI and how you can use socially responsible mutual funds to incorporate this strategy in your portfolio.

What Is Socially Responsible Investing?

A socially responsible investing strategy is one that views successful investment returns and responsible corporate behavior as going hand in hand. SRI investors believe that by combining certain environmental, social, and governance (ESG) criteria with rigorous investment standards, they can identify securities that will earn competitive returns while helping build a better world.

SRI analysts gather information on industry and company practices and review these in the context of a country’s political, economic, and social environment.

Generally, these seven areas are the focus of socially responsible investors:

1. Corporate governance and ethics
2. Workplace practices
3. Environmental concerns
4. Product safety and impact
5. Human rights
6. Community relations
7. Indigenous peoples’ rights

It should be noted that SRI is essentially promoting adherence to the positive aspects of these areas with publicly held companies. However, SRI also gets a lot of attention for industries and companies that it opposes as “bad” for society. The latter would include, among others, businesses involved in gambling, tobacco, weapons, and alcohol. These so-called sinful investment categories are often eliminated from holdings through SRI screening.

Socially responsible mutual funds hold securities in companies that adhere to certain social, moral, religious, or environmental beliefs. To ensure that the stocks or bonds chosen embody values that coincide with the fund’s principles, company issuers undergo a careful screening process. An SRI mutual fund will only hold securities in companies that adhere to high standards of good corporate citizenship.

What Are Socially Responsible Mutual Funds?

Because people have such a wide variety of values and beliefs, fund managers have significant challenges in determining which stocks reflect the optimal combination of values for attracting investors. The criteria used when screening for stocks depend on the fund’s theme, values, and goals.

For example, funds with a strong sensitivity toward issues of environmental concern will pick stocks in companies that go beyond fulfilling minimal environmental requirements.

Many socially responsible mutual funds also will earmark a portion of their portfolios for community investments. A common misconception is that these investments are donations. This is not the case. These investments allow investors to give to a community in need while making a return on their investment. Many community investments are put toward community development banks in developing countries or in lower-income areas of the U.S. to be used for affordable housing and venture capital.

Ownership Is Taken Seriously

Shareholder activism, sometimes referred to as company engagement, is one of the most important hallmarks of SRI funds. They use their ownership rights to influence management through policy-change suggestions. This advocacy is achieved by attending shareholder meetings, filing proxy proposals, writing letters to and meeting with management, and exercising voting rights.

Because it is difficult for fund shareholders to exercise their votes individually, voting is achieved by proxy; fund shareholders assign management to vote on their behalf.

Proof that individuals can make a difference is illustrated by the proposal the Securities and Exchange Commission (SEC) passed in January 2003, which states that all mutual fund companies must disclose proxy voting policies and procedures and their actual votes to their shareholders. The SEC’s decision was brought about by thousands of proposal requests sent to the commission by socially responsible investors.

Does Good Triumph Over All?

As an investor, you can’t be completely philanthropic, expecting nothing in return for your investment other than the feeling of having invested in a company that reflects your own values. So how does the performance of SRI mutual funds measure up to that of a conventional portfolio?

On average, the performance of SRI funds has been close to that of regular mutual funds. There are several indexes that track the performance of stocks considered to be socially responsible investments. According to MSCI, the annualized gross returns for the MSCI KLD 400 Social Index (initially called the Domini Social 400 Index) between July 30, 1999, its inception date, and June 30, 2022, were 6.55%. Over the past 10 years, the index has delivered a 13.31% annualized return, compared with a 12.65% annualized return from its parent index, the MSCI USA IMI, which comprises a broad set of small-, mid-, and large-cap U.S. companies.

The Price of Doing Good

SRI mutual funds sometimes have higher fees than regular funds. This premium in fees can be attributed to the additional ethical research that mutual fund managers must undertake. In addition, socially responsible funds tend to be managed by smaller mutual fund companies, and the assets under management (AUM) can be relatively small. Under these circumstances, it is difficult for SRI funds to make use of the economies of scale available to their larger rivals.

Keep a Level Head

Before you let your emotions become your investment advisor, it is wise to maintain a level head. Here are some important tips to follow to maximize your chances of earning decent returns and investing in qualified SRI funds:

1. Get Informed—Learn about SRI, which funds qualify using these criteria, and where you can buy them.
2. Know Your Values—Everybody’s values are different. Some may feel strongly about environmental causes, while others are more concerned with social programs. Rank your concerns. Once you have established a few top values, you may narrow your fund choices to a few select funds whose values closely match your own.
3. Go Beyond Your Values—Research the fundamentals and fees of the funds in which you are interested. Some items to consider include the level of the management expense ratio, the cost of load fees, the fund manager’s track record, and how the fund has performed over the past few years. There is no need to sacrifice investment quality when considering an SRI mutual fund. Do your homework as you would for any kind of fund investment.
4. Diversify—A consequence of investing in SRI funds is that you may be limiting your investment to a few companies that have a lot in common socially, ethically, and financially. Think of a sector fund with a portfolio formed mainly from stocks in the tech industry. If you had all your eggs in that basket during the internet market crash of 2000 to 2002, for example, all of your eggs would have been broken. If your overall investment is placed strategically in different types of holdings, the possibility of losing all your assets is minimal. If you want to be a socially responsible investor, it is still possible to diversify your portfolio with other stocks, bonds, or U.S. Treasurys without compromising your values. Investing more broadly in socially responsible securities with values that differ somewhat from the focus of your chosen fund can help.

The Bottom Line

SRI opportunities suggest that investors need not compromise their values to make money. If you approach SRI mutual funds like any other investment, you may be able to put your money into securities and companies that align with your values—while potentially boosting your investment account balance.