These Socially Responsible Funds Strike the Right Balance

Many investors are attracted to the concept of investing in companies whose values align with their own. Examples include firms that offer safe, employee-friendly workplaces, don't pollute the environment, and don't make products that are harmful to human health, such as tobacco.

In practice, however, the universe of so-called socially responsible investments is a difficult one to navigate. This large group encompasses broad-based, secularly oriented funds as well as those geared toward members of specific religious groups and ones that focus on a specific social issue, such as the environment. Investors can't trust that funds' screens will align with their own simply because they fall under the broad socially conscious banner.

Moreover, screening on social or religious issues can have meaningful repercussions when it comes to portfolio construction and diversification, ruling out some industries altogether while forcing heavy weightings in others. Many secularly oriented socially responsible funds tend to skimp on basic materials and energy stocks because of environmental considerations, for example, while taking larger positions in technology and financials stocks. Those biases helped in the second half of the 1990s, when both financials and tech were on a roll, but have been a hindrance at other points in time.

With an eye toward identifying those socially responsible funds that have balanced sector diversification with fairly strong long-term results, I turned to our  Premium Fund Screener. I started with those domestic-equity funds that have been tagged as socially responsible because of specifications in their prospectuses. To help home in on those offerings that don't have dramatic sector biases, I looked for those with R-squareds with the S&P 500 of 90 or higher. R-squared is a measure of performance correlation; an R-squared of 100 indicates that the performance of two assets is highly correlated. R-squared doesn't directly measure sector diversification, of course, but it's unlikely that a fund whose portfolio is dramatically different from an index's would behave similarly to it.

Of the funds that made it through my screen, I further winnowed down the list by screening for those whose 10-year returns were higher than that of the broad market, as measured by the Russell 1000 Index. Finally, because above-average expenses can be a problem among socially responsible funds, I screened for those offerings with expense ratios less than their category averages.

Socially responsible investors will still have to do their homework to determine whether a fund's mandate aligns with their values; Morningstar's  Analyst Reports describe the social criteria a fund employs. It's also worth noting that my screen aims to identify funds with balanced sector exposure, but some socially conscious investors would prefer to avoid industries such as energy and basic materials at all costs, even if it means their funds' performances differ from that of the broad market from year to year.

Those caveats aside, our analysts like some of the funds my screen turned up. Premium users can click  here to view the screen and its complete output; I've highlighted three of the better options below.

 Neuberger Berman Socially Responsive (NBSRX)
In contrast with hard-line socially responsible funds, this offering takes a relativist approach to social screening, focusing on the most socially responsible firms within industries that some of its peers eschew altogether. For example, although it features a sizable position in the financials sector--a fixture in many socially responsible funds--it also includes an above-market weighting in the energy sector, which some rival funds won't touch. Would-be shareholders will have to determine if they're comfortable with that relativism, but the fund looks good from a variety of different angles. Arthur Moretti and Ingrid Dyott are seasoned managers who employ a sound, valuation-conscious strategy, and the fund's expenses are below-average. One fly in the ointment for do-it-yourself investors: The no-load Investor shares are closed to new investors, but the A shares ((NRAAX)) are open to all.

 Parnassus Equity Income (PRBLX)
Despite the "equity income" in its name, this fund's yield is actually below the S&P 500's, owing to its expenses as well as the inclusion of nondividend payers like  Google (GOOG) in its portfolio. Despite that dearth of income, Morningstar analyst Rob Wherry thinks the fund is a suitable core option for socially conscious investors. As is the case for the Neuberger Berman fund, this fund's manager, Todd Ahlsten, is a seasoned hand who diversifies across sectors and pays attention to valuations. And though performance has been streaky--2010 was a recent off year--Ahlsten has generated a very strong risk/reward profile during his tenure.

 TIAA-CREF Social Choice Equity (TICRX)
Even more than the aforementioned offerings, this fund's sector exposure hews closely to that of the S&P 500, making it a good option for those in search of one-stop socially conscious market exposure. Morningstar analyst David Kathman notes that the fund screens a broad universe of companies for those that look best based on five criteria, including employee relations and environmental track records. Management holds roughly 700 companies altogether, including stocks across the market-capitalization spectrum. Because of its indexlike approach, the fund has fairly low costs, a competitive advantage within the often-costly socially responsible universe. Note that my screen picked up on a high-minimum-purchase institutional share class, but a retail share class is available to smaller investors with a minimum initial purchase of $2,500.    

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