Ethical investments: A shelter from the stock market's storms?
Socially responsible funds may screen out bad apples, but they haven't escaped market volatility.
from the March 26, 2007 edition
Page 2 of 3
SRI funds statistically more volatile
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.
"To the extent that wealth has been created [in African-American households], it's been through home ownership and the equity appreciation obtained through a mortgage," says Eric Stein, senior vice president of the Center for Responsible Lending, a nonprofit that fights predatory lending. "The explosion in the subprime mortgage market – [which] has developed over the last four years – has been, I think, the largest threat to that wealth in American history, aside from slavery."
Some in SRI made a point to steer clear of sub-prime lenders. KLD's Domini 400 Social Index, for instance, delisted Household Finance back in December 2002 after the company settled a predatory lending case brought by multiple states, according to Director of Research Eric Fernald. SRI funds using that index as a guide would probably not own certain firms that are players in the sub-prime market. And those that aren't vigilant about screening out subprime lenders should become more so, says Doug Wheat, a Northampton, Mass., financial adviser with an SRI specialty.
"It is both a moral and financial risk issue" for SRI investors, Mr. Wheat says. "If the mutual funds aren't active in screening out [predatory lending], they should encourage the mutual funds to change their practice."
But some SRI funds give the entire finance industry a wide berth. Those with an environmental emphasis often load up on financial institutions in their portfolios because theirs is largely a nonpolluting industry. The Vanguard FTSE Social Index, for instance, has 40 percent of its holdings in financials. The Sierra Club Stock Fund has a 30 percent exposure to financials, more than any other sector in its portfolio. Although the Sierra Club Stock Fund screens out firms cited for deceptive practices, it allows for subprime lending and includes two of the nation's largest players in that market: Wells Fargo and Countrywide Financial.
"The subprime market in itself does not equal predatory and in fact can be beneficial," says Garvin Jabusch, portfolio manager for the Sierra Club Stock Fund. "In a lot of cases, if there isn't a subprime lender, some people with questionable credit are never going to own a home. We actually think that a responsible subprime lender is socially valuable."
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