Fund Spy

Values Investing: A Look at the State of SRI Funds

William Samuel Rocco

Investors who are considering socially responsible investing funds have a larger set of choices than ever before. Sure, there has been some consolidation among screened funds over the past year or so, just as there has been among non-screened funds. For example, Ave Maria Rising Dividend (AVEDX) absorbed Catholic Equity Fund in 2007. But the universe of such funds has expanded significantly in the 2000s. There were fewer than 100 funds at the end of 1999. But the number increased to 134 by mid-2004, and there are more than 165 screened funds today. The total should continue to grow, as some fund families have new SRI offerings in the works.

The set of SRI funds has become broader as well as bigger. Secular SRI funds dominated the universe a decade ago, but faith-based offerings have been launched at a fairly rapid rate in the 2000s and now make up more than half the total of all SRI funds. In the meantime, the number of green funds has increased from less than one dozen five years ago to nearly three dozen today. Further, several of the newer SRI options are in investment categories that previously had few if any screened offerings, including  Appleseed Fund (APPLX) (a secular SRI fund in the mid-value group), Leuthold Global Clean Technology LGCTX (a green fund in the world-stock group), and MMA Praxis Small Cap (MMSCX) (a faith-based offering in the small-growth category).

But investors considering the universe of SRI funds will find that it still comes with real challenges. First, in addition to the social screens that differentiate secular, faith-based, and green subsets from each other, there are significant screening variations within each of these subsets. Second, most SRI funds tend to have significant sector biases. Third, though the universe has expanded, there still are a limited number of attractive screened funds in many categories, making it difficult to create a well-diversified, all-SRI portfolio.

Pick Your Protocol
On the surface, secular-SRI funds seem to share many of the same screens and social criteria. They generally avoid firms with links to tobacco, alcohol, firearms, or weapons contracting, as well as those with significant environmental, workforce, or human-rights problems. They tend to favor companies that are leaders in the areas of environmental sustainability and employee relations.

But there have been a few changes in recent years. Some secular funds, such as  Pax World Balanced (PAXWX), can now own firms with ties to alcohol. And secular funds differ in how consistently and strictly they apply their social criteria, which ones they emphasize, and whether they take proactive steps to advance their social agendas or not. SRI funds such as  Neuberger Berman Socially Responsive (NBSRX) that belong to families that focus on non-SRI offerings tend to invest more readily in the least-offensive firms in problematic industries for diversification purposes. They also tend to engage in less shareholder activism than do pure-SRI shops' funds, such as  Domini Social Equity (DSEFX).

The three main types of faith-based funds are Catholic, Protestant, and Islamic, and they, too, have many similarities when it comes to their social criteria. All of these funds shun companies involved with alcohol, gambling, tobacco, and pornography. The funds vary considerably, however, in their overall philosophies and in some of their specific screens.

The Catholic Ave Maria funds and the Protestant Timothy funds have conservative outlooks and avoid what they consider to be "anti-family" companies (such as those that offer domestic-partner benefits to their employees). The Catholic LKCM Aquinas funds, the Protestant New Covenant offerings, and the Protestant MMA Praxis funds have fairly liberal worldviews and employ environmental-responsibility, social-justice, and other criteria that are similar to those used by secular offerings. The Islamic Amana and Azzad funds shun banks and other financials-services firms as well as pork producers.

Green funds employ a wide range of criteria. Those that focus on companies that are involved with one particular environmentally beneficial product or service, such as  PowerShares Global Wind Energy PWND, are at one end of the spectrum. Funds that invest in a diverse mix of firms that have better environmental track records than their industry peers are at the other end of the range. Funds--such as  Winslow Green Growth WGGFX--that pursue specific types of companies that either provide environmental solutions or operate in environmentally responsible manners fall in between.

Beware of Biases
Primarily because of their environmental- and workforce-related criteria, secular funds tend to be light on the traditional value sectors and heavy on mainstream growth sectors. The typical secular large-cap fund, for example, has far less energy exposure and far more hardware exposure than the S&P 500 Index. Meanwhile, the average secular foreign large-cap offering has much less industrial-materials exposure and much more health-care exposure than the MSCI EAFE Index. And while some secular funds have more marketlike sector exposure (because of their willingness to invest in the least-problematic firms in certain industries), other secular funds have more skewed sector stances for one reason or another.  Vanguard FTSE Social Index (VFTSX), for example, has a hefty financial stake along with paltry industrial-materials and energy positions and sizable hardware and health-care weightings--all because of the social criteria embedded in its underlying index.

The screening criteria of the Catholic and Protestant faith-based funds generally don't lead to sector biases as pronounced as the secular offerings'. That said, Ave Maria Growth (AVEGX) and other conservative Catholic and Protestant faith-based funds tend to have zero or minuscule stakes in the media sector because of their "anti-family" screens. Some of the more-liberal faith-based funds have relatively moderate positions in the commodity-related sectors as a result of their environmental screens. As would be expected, the Islamic funds always have zero exposure to banks, insurers, and financial-services firms--which make up a sizable portion of the S&P 500 Index--though some do invest in real estate companies (which Morningstar classifies as financials).

The green funds that look for a diverse mix of environmentally superior companies and incorporate non-environmental screens into their processes tend to have hefty hardware and health-care stakes, limited energy positions, and moderate weightings in most other sectors. Meanwhile, those that focus on just a few types of environmentally responsible firms tend to be extremely concentrated.  New Alternatives (NALFX) usually invests the bulk of its assets in industrial-materials and utilities issues.  PowerShares WilderHill Clean Energy (PBW) normally devotes the vast majority of its assets to industrial-materials stocks and hardware names.

Mixed Bags of Opportunities
Large-blend, large-growth, and moderate-allocation funds that focus on blue-chip blend or growth stocks dominate the secular SRI universe But most of them are middling or subpar choices. There are some good ones, though, including Neuberger Berman Socially Responsive--a large-blend fund with a skilled skipper and focused style--and Pax World Balanced--a fine moderate-allocation offering that boasts a distinctive strategy and a distinguished record.

Although a number of secular value, smaller-cap, and international funds have been launched in recent years, there still are fewer than 15 such funds. One of the newer ones, mid-cap value Appleseed Fund, has shown real promise, but most of the others are too unproven, mediocre, or flawed to be worthwhile options at this point. And while there's a solid secular bond fund or two, there are no secular specialty-equity offerings, other than several green funds and ETFs that fall in the energy or natural-resources groups.

The faith-based SRI universe is more balanced than its secular counterpart. These funds are spread fairly evenly across the domestic categories of the Morningstar Style Box. For starters, there are a handful of faith-based large-value funds as well as a number of large-blend and large-growth offerings. There are a few mid-value funds plus several smaller-cap blend and several smaller-cap growth offerings. There also are six faith-based international-stock funds, a few specialty offerings, an assortment of bond funds, and a multitude of allocation offerings.

A variety of the faith-based domestic-equity funds are fetching options.  Amana Income (AMANX) is a topnotch large-value vehicle that's run by one of the finalists for Morningstar's 2006 Domestic-Stock Manager of the Year award.  Amana Trust Growth (AMAGX) is a first-rate large-growth offering that's run by the same skipper. LKCM Aquinas Value (AQEIX) is an attractive large-blend fund that's managed by the same team and in a similar manner to the highly successful  LKCM Equity (LKEQX) (which is not a faith-based offering). Some of the faith-based allocation and bond funds are pretty good choices, too. But none of the faith-based international-stock funds is a compelling choice at this point, and there aren't a lot of great smaller-cap options.

There only are a handful of green funds that are large-cap-oriented and diversified enough by sector to serve as a core holding.  Portfolio 21 (PORTX) is one such offering. The world-stock fund has a strong management team that has succeeded by picking firms from a variety of industries that are integrating environmental sustainability into their business strategies.

The rest of the green universe is dominated by bold commodity-related offerings and smaller-cap offerings. Winslow Green Growth is one of the latter. Though it is rather focused and extremely aggressive--and thus is prone to huge losses in adverse conditions--it has considerable upside potential, seasoned skippers, and a purview that isn't quite as narrow as those of most other green offerings.

Extra Steps
Investors who are seeking SRI funds certainly don't face as many obstacles as they once did. But they still need to do some extra research and realize that major challenges remain. Because social screens vary across (and even within) the secular, faith-based, and green universes, it's necessary for investors to review the intricacies of funds' screens, principles, and activities to make sure that they're consistent with their values. Also, given the sector biases of many SRI funds and the limited number of strong offerings in some categories, investors will find that it remains difficult to build well-diversified portfolios constructed entirely of good-quality secular, faith-based, or green funds.


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William Samuel Rocco has a position in the following securities mentioned above: VFTSX. Find out about Morningstar's editorial policies.