Ethical investments: A shelter from the stock market's storms?
About five years ago, when accounting scandals were roiling stock markets, promoters of socially responsible investments (SRI) trumpeted their social-screening criteria as effective tools to keep bad apples – and big losses – out of one's portfolio.Skip to next paragraph
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Now jittery stock markets, spooked in recent weeks by two of the biggest single-day dips in years, suggest that some investors could use a steady keel in their portfolios. Among the top issues is whether ethical investments can be a haven from an imploding subprime mortgage market and its ripple effects.
But history suggests that SRI mutual funds have been no panacea for avoiding a bumpy road. And if the financial sector stumbles, as some analysts predict, then short-term results this time around are apt to depend largely on whether screens used by particular SRI funds have served to lessen or heighten related risks.
In a March analysis of the most volatile market years of the past two decades, fund tracker Morningstar found that SRI investors tend to feel the pain of plunging markets even more than other investors do. Plus, when fluctuating prices have led to big gains, SRI funds have missed part of the party. Consider:
•When the stock market struggled in 1987 and 1990, SRI funds trailed the benchmark S&P 500 index by more than three percentage points in each year.
•In the volatile heyday of the technology boom in 1998 and 1999, SRI funds posted gains that fell 10 and two percentage points below the S&P's in respective years.
•Even in 2002, when terrorism fears and corporate scandals dragged the market down, SRI funds overall lost 23.2 percent of their value while the S&P 500 lost 22.1 percent.
Despite these findings, ethically driven strategies have at times paid off for investors. KLD Research & Analytics' benchmark Domini 400 Social Index, for instance, has since its inception in 1990 outperformed the S&P 500 in cumulative and annualized returns. But investors guided by that index have had a wild ride. Over 17 years, the index has been 6.35 percent more volatile than the S&P, which points to more price fluctuation in the portfolios of investors, according to KLD Business Development Manager Chris McKnett.
Conclusion: SRI funds are usually not a haven in volatile periods. As a result, ethically minded investors need a long-term horizon, say industry veterans. It also means they need to consider whether the funds they own are positioned to prosper or flounder as a result of current trends.
"There is more volatility generally in a socially conscious portfolio than in a portfolio that's more equally weighted across all market sectors," says Steve Scheuth, president of First Affirmative Financial Network, a Colorado Springs, Colo., money-management firm with an SRI focus. "What that means is that in certain market environments we do better [than other investors]. And in certain market environments, we don't do so well."
Volatility refers to the degree of movement in stock prices – up, down, or both. When stock prices on average are rising or falling 1.5 percent more than they normally do on a benchmark index, such as the S&P 500, then a period is especially volatile. In the past two decades, the most volatile times have occurred during the early stages of recessions as well as during lofty bull runs.
Steady growth has characterized stock markets over the past four years, and it's too early to tell whether that trend is finished. Investors have displayed signs of nervousness in the past month, however. The most recent sell-off came March 13 in the wake of news that lenders specializing in subprime mortgages, which charge high interest rates over time and levy hefty fees for noncompliance, faced mounting defaults and were tightening controls.
How ethical investors should approach subprime lending is a matter of debate. Some activists believe the practice is not only risky for investors but is also a moral scourge because it sets up the vulnerable to fail.