Socially responsible investing: Can fund screens be trusted?
Knowing whether funds live up to their promises to weed out certain companies remains a tall order.
Somebody needs to be keeping a closer eye on those who aspire to hold companies to high ethical standards.Skip to next paragraph
Subscribe Today to the Monitor
That's one of the key lessons observers are gleaning in the aftermath of a humbling episode for Pax World Funds of Portsmouth, N.H. The firm agreed this summer to pay a $500,000 penalty for having invested, over a four-year period, in companies that were off-limits because of their social and/or environmental practices. The case marked the first time the Securities & Exchange Commission had fined a socially responsible mutual fund for neglecting its own screening criteria.
Having caught one socially responsible (SR) mutual fund company in the act of failing to keep its promises, regulators at the Securities & Exchange Commission appear ready to find more.
But is government oversight enough to give investors peace of mind?
Investors have a lot riding on whether SR funds do as they pledge to do. If a fund takes more risk than advertised, for instance, a conservative investor could be surprised in a market downturn, such as mid-September's, to find a bludgeoned portfolio. And if a fund neglects to follow its social or environmental guidelines, then investors aren't getting the service for which they've paid higher-than-average expense ratios.
Some industry observers are taking heart in the prospect of more aggressive regulation of SR funds in years to come. But others are urging investors to be more proactive. Their prescription: Watch for a few telltale indicators of whether a fund has solid monitoring systems in place – or if it's vulnerable to a Pax-type lapse.
In certain circles, confidence in SR funds continues to run high. Justin Harris, a Seattle-based financial adviser with a specialty in SR investing, says he doesn't hesitate to plug investors into a range of SR funds, especially now that regulators seem to be paying fresh attention to the sector.
"I believe in the power of the spotlight," Mr. Harris says. "It brings attention to individuals, companies, and mutual funds [because] people all of a sudden say, 'We've got to make sure we get our act together now.' "
Some investors seem to share that sentiment. Seven of Pax's eight funds have seen a net inflow of investment dollars and an increase in investor numbers since the SEC settlement announcement on July 30, according to President and CEO Joe Keefe.
Not everyone, however, believes it's time to relax. The Pax debacle could serve as a useful wake-up call to investors who may have grown a bit complacent, according to David Wood, director of the Institute for Responsible Investment at Boston College.
"I don't think Pax is the only fund to ever have a screen slip," Mr. Wood says. "The news about Pax reminds people that they need to pay attention."
For individual investors, checking up on the practices of mutual funds could quickly become technical, tedious, and time-consuming in the absence of a few, easy-to-read indicators. Since the industry isn't a simple one to decipher, nonprofessionals shouldn't bother to do their own analysis of a fund's internal monitoring systems, according to David Tittsworth, executive director of the Investment Advisors Association, a professional trade group based in Washington, D.C.