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Socially Responsible Investing Is Its Own Reward

SRI funds can't shelter investors from corporate fraud.

It was probably inevitable.

In the wake of all the recent accounting scandals and the stock market's general malaise, the financial media has been rife with stories pondering whether socially responsible investing (SRI) might have helped shareholders sidestep landmines such as Enron , Global Crossing , and Adelphia Communications .

It's an irresistible angle, of course, a simple solution to a complex problem that draws a silver lining around one ugly cloud.

But is it true? Well, not exactly. SRI funds are aptly named since what separates them from the pack is that they limit their investable universe through various social screens.

Consider, for instance, Domini Social Investments. The firm is one of the better-known players in the SRI field, clocking in with $1.6 billion in assets under management as of the end of June 2002. Domini's screens eliminate companies that have ties to tobacco, alcohol, and gambling. They also exclude military contractors, as well as firms that own or operate nuclear power plants or manufacture firearms. True, Domini wants the companies it invests in to be good corporate citizens. But the firm largely defines that elusive quality in terms of generous charitable giving and support for public education and affordable housing.

Those are all worthy pursuits, but none of them, however, prevented Domini from including Enron in its 400 Social index. According to its July 2001 shareholder report, in fact, the  Domini Social Equity Fund (DSEFX), which tracks the index, held a sizeable position in the now-bankrupt energy concern. And Domini wasn't alone: Along with Global Crossing and Adelphia, for example, Enron also appeared in the social index created and maintained by Calvert, another SRI industry behemoth.

Many SRI funds held Enron precisely because the company was able to pass through fairly stringent social screens en route to various shops' socially responsible portfolios. But social screens can't ferret out fraud, unfortunately. And in itself, an SRI designation doesn't indicate anything about a fund shop's team of researchers and analysts or their accounting acumen, which is precisely what analyzing Enron's infamously opaque financials--as opposed to, say, its environmental track record--required. The fact is, financial analysis and social analysis are two distinct disciplines. Each requires a different skill set, and success in one area just doesn't presage success in the other.

That said, shops such as Calvert and Domini have impressive track records for shareholder activism. Calvert, in fact, recently adopted new corporate-governance screens, with a broad mandate of excluding companies whose "business practices have compromised the interests of shareholders." Moreover, some players in the SRI industry were early in pointing to the inherent conflicts of interest posed by companies that employ the same firm for both auditing and consulting work. And the industry is currently in the thick of the fight for greater corporate disclosure regarding factors such as executive compensation and the independence of board members.

Still, if that battle ultimately leads to tangible results, all investors will potentially benefit since analysts will then be equipped with more of their discipline's most precious commodity: information. What those analysts choose to do with that information will define the quality of their work and that of the funds they support--whether or not those funds are socially responsible. Ultimately, investing in a way that's consistent with your values should be its own reward.

Shannon Zimmerman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.