2000 Update: How Do Socially Responsible Funds Sta

For years, socially responsible (SRI) funds have fought the perception that adding social criteria to the investment process automatically hurts an investor’s chances of achieving strong returns. Restricting the investable universe of stocks using social criteria is likely to put those investors at a disadvantage, so the argument goes, to those who can choose from a wider array of stocks.

However, a number of SRI funds have cast doubt on that argument in the last few years, demonstrating that it is possible to achieve strong returns while investing with your values. A study done by Morningstar in 1999 showed that SRI funds had turned in strong performances relative to the broad universe of funds as well as alongside their category peers, and had made great strides since 1997.

A year after we last looked at how they stack up, SRI funds as a group are still hanging tough. However, their numbers don’t look quite as rosy as they did in 1999. A tough year for technology, and especially mega-cap tech stocks, can take a lot of the blame for the funds’ slide. These latest figures also point out the potential pitfalls for investors looking to build an entire portfolio out of socially responsible funds.

The Numbers
Through August 31, 2000, nine out of 68 SRI funds, with records of three years or more, had notched 5-star ratings--a rate of about 13%. That’s good enough to edge ahead of the broader fund universe as only 10% of funds in Morningstar's universe receive 5-star ratings. Still, that percentage has fallen substantially since last year, when 21% of SRI funds with records of three years or more boasted 5-star ratings.

The funds’ category ratings have fallen off a bit in 2000 as well. Twenty-one out of 68 SRI funds in Morningstar’s database, with three or more years of history, clock in with category ratings of 4 or 5. Although that's right in line with the typical distribution of top-category ratings for the broad universe of funds, it's well below socially responsible funds' standings in 1999, when fully half of SRI funds garnered category ratings of 4 or 5.

Rocked by the Tech Wreck
You don’t have to look too hard to account for the slide in SRI funds’ ratings this year. Many SRI funds are weighted heavily in tech stocks because those companies often pass their environmental and workplace screens. By the same token, SRI funds often invest little or nothing in traditional value sectors like energy and utilities, because companies in those sectors tend to fail their screens. Being so heavy in tech (and so light on value-priced energy and utilities names) was a huge boon for these funds in the last couple years, because growth stocks were all the rage in the market.

But beginning in 2000’s second quarter, tech stock performance has been rocky, while the energy and utilities sectors are having banner years. This trend has bruised SRI funds' rankings within the overall fund universe and within their peer groups. Among the SRI funds that rode tech to great gains in 1999 (only to come in for some pain in 2000) are DEM Equity  and Domini Social Equity (DSEFX). Both offerings' tech stakes are substantially higher than average for their peer groups.

Even funds that apply a value strategy to the socially responsible universe are having a rough go of it in 2000, despite a somewhat better environment for that style. Meyers Pride Value , a mid-value offering with a strong long-term record, has also been feeling pain this year; in part because it downplays traditional value sectors, like energy, in favor of fallen-angel growth stocks. That fund’s 26.7% tech stake towers over that of its mid-value average peer, which stashes only 11% in tech. After a fantastic 1998 and 1999, the fund has tumbled to the mid-value group’s bottom quartile.

As information about those companies' employment screens and other social factors is much more plentiful than for smaller firms, many SRI funds have bigger-than-average stakes in mega-cap stocks. That mega-cap bias was a huge boost for funds like Domini Social Equity and Citizens Index  in 1998 and part of 1999, but it has been a disadvantage more recently as giant-cap names such as Microsoft (MSFT) and Home Depot (HD) have tumbled. Domini Social Equity has been shellacked this year--its 8% loss through the end of September lands in the large-blend category’s cellar. Citizens Index , another SRI large-cap heavyweight, is down 6% on the year.

In a Challenging Year, A Few Highlights
It’s not all bad news for SRI funds this year, however. For example, Citizens Emerging Growth’s  24.8% year-to-date return lands near the mid-cap growth category’s top quartile. That fund’s tech stake soaks up more than half its portfolio, but its managers are navigating that sector’s rocky terrain successfully this year. Another SRI fund that’s having a great year is Green Century Balanced (GCBLX), a small-growth offering that is trouncing its competition with a 40% return through September 28. This racy fund holds a sizable chunk of biotech and micro-cap technology issues that have skyrocketed this year.

And even though it’s been a challenging year for SRI funds performance-wise, the industry has made big strides in other ways in 2000. The introduction of low-cost, socially responsible index funds from Vanguard and TIAA-CREF is setting a new standard for expenses in a high-cost industry. Both the Vanguard and TIAA-CREF offerings charge expense ratios of less than 30 basis points. This is great news for social investors, because expenses in the SRI group tend to run high, even for passively managed funds like Domini and Citizens Index. In addition, new funds like Citizens Small Cap Index  are giving social investors the tools they need to build diversified portfolios.

Conclusion
Although many socially responsible funds have notched solid long-term performances, 2000's rough market has revealed kinks in certain funds' armor. A fund’s social criteria might be exactly what you’re looking for, but its racy portfolio--and penchant for volatility--may leave you cold. Just as SRI managers use another layer of research to weed out companies that don’t fit their social criteria, social investors should dig a bit more to see if a fund’s social and financial stats are right for them.

This year’s lackluster performance for SRI funds also might motivate SRI fund companies to consider rolling out value-oriented offerings. Though it’s easier to build a socially screened portfolio with a growth tilt, even social investors need to build balanced portfolios.