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.
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"A lot of investors don't even bother to read fund prospectuses," Mr. Tittsworth says. "It's a pretty tall order for an armchair investor [to determine], 'Is the information, which you've just read and hopefully understood in a prospectus, questionable in any way?' "Skip to next paragraph
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But others argue such an in-depth analysis isn't necessary to ascertain whether a fund has solid safeguards in place. The alternative they recommend is to ask an investor-relations department whether certain structural features are in place or not.
One approach might be to look for systems like those now in place at Pax. As part of its deal with the SEC, Pax has introduced new monitoring tools that number among the most foolproof in the industry. Among the additions: a new, easy-to-read database that clearly indicates what's investable and what isn't; daily reviews of all transactions by an expanded team of compliance officers, who make sure no prohibited firms have landed in a fund's portfolio; and an automated trading system that blocks the purchase of any unapproved security.
Pax has also beefed up its social research department. There, staffers determine whether a company meets its social screens or not. Investors would always be wise to investigate whether a fund company does its own social research in-house because it's a sign of a "serious review" process, according to Tim Smith, director of socially responsive investment at Walden Asset Management.
Mr. Smith says investors could also ask: "How often do you review and evaluate companies that are in a process of change [to determine]if they're changing their character?"
Others, however, want to see more structural safeguards in order to feel confident. In-house social research runs a risk of being compromised when it's done by the same department that analyzes whether a stock or bond is a good buy, according to Paul Hawken, executive director of the Natural Capital Institute, a California-based nonprofit that's faulted SR funds for using lax screening methods. He says financial and social research should be strictly separate, just like editorial and advertising departments in newspapers, in order to be sure some companies are excluded – even when they're good candidates to deliver handsome returns.
"The performance pressures are so great that research gets diffuse and becomes almost meaningless" when research departments are combined, Mr. Hawken says.
Doing in-house social research, as opposed to buying lists of supposedly conscientious companies and investing in them, comes with pros and cons. A well-staffed social research arm can help ensure that investors' values are reflected in their portfolios, according to Brad Barber, director of the Center for Investor Welfare and Corporate Responsibility at the University of California, Davis. But research is expensive, he notes, and investors pay a premium – usually more than 1 percent of assets under management – to get such a vigilant internal monitoring system.
As a proponent of low-cost investing, Mr. Barber suggests an alternative strategy for ethically minded investors. Look for funds pegged to socially screened indices, such as the FTSE For Good Index or the Domini 400 Social Index. By relying on widely disseminated social research, as opposed to customized in-house research, investors can save a bundle while still enjoying peace of mind that comes with an active monitoring system.
"While I like the idea of thinking about values when we are saving for retirement, I'm also a little bit uncomfortable recommending that investors spend a lot of money on the expenses that are charged by [actively managed] funds," Barber says. "These socially screened indexes … are probably going to satisfy the values of a broad section of the population."