Socially responsible investing is about to enter Phase 2.
The first phase involved proving that small investors can do relatively well over time by quietly backing companies that "do good."
Now SRI investors are being told not only can they make a profit, but they also can drive real cultural and political change within corporate America starting with the reform of corporate governance. All they need to do is deepen their commitment to SRI as a cause.
That message came from many who attended an SRI conference held here last month. SRI officials celebrated having won more support from "mainstream" investors and laid plans to develop even more of the ethical and social screens used to assess whether to include a company's stock within an SRI portfolio.
Some within the SRI movement want to provide investors with mutual funds that take a much more aggressive stance on fighting gender discrimination (including getting more women on corporate boards), promoting native American rights, and opposing excessive pay to corporate officers.
They also hope to expand shareholder activism, although some are more eager than others to advance this reform. In addition to representatives from SRI fund groups, community activists, representatives from church groups, pension-fund over-sight officials, and activist-oriented local mutual-fund representatives also attended the conference.
Such factions have traditionally pursued separate agendas. Today that is less often the case. "It has come to the point where all the circles are starting to cross each other," says Anita Green, director of research for the Pax World fund group, headquartered in Portsmouth, N.H.
The SRI community has consistently been far more activist than the larger and more traditional mutual-fund industry. In part, some analysts say, the activism may reflect the large number of women leaders within the SRI community, who may be more interested in social issues than their more profit-oriented male counterparts at old-line funds.
The heads of the Citizens Fund Group, the Calvert Group of Funds, and the Domini Social Equity Fund, perhaps the best known SRI fund, are all women.
Regardless of who runs SRI funds, a key question is whether investors accustomed to using screens to gently steer their portfolios away from various social or economic vices will embrace a more activist approach.
Pushing an agenda of greater shareholder activism will not drive investors away, says Laurie McClain, a financial adviser and SRI enthusiast in Eugene, Ore. Rather, she says greater shareholder activism, especially on matters of corporate governance, will attract more investors to SRI products.
"Ethics have never really gone out of fashion. Folks have watched a lot of their stocks go down in value, but they are now looking for answers and help when it comes to wise investing," says Ms. McClain. "We are a proactive and activist industry."
Some analysts, however, believe the SRI community must walk a careful line between political action and seeking better corporate governance. "Public disclosure is a good thing. I just don't think it is wise to use corporations to enforce a political or social agenda," says Hans Stoll, who heads up the Financial Markets Research Center at Vanderbilt University, in Nashville, Tenn. "That's for the political sector."
One sign of the SRI industry's more activist approach is its backing of a proposal before the Securities and Exchange Commission that would require mutual-fund groups to disclose how they vote on proxy questions. The SEC is taking comments on the issue until Dec. 6.
In 1999, Domini Social Investments became the first US mutual-fund group to do so voluntarily. The company now annually issues guidelines to its investors explaining its positions on matters of corporate governance and social responsibility.
Proponents of proxy voting disclosure believe that shareholder pressure can promote healthy reform. Amy Domini, who heads up the Domini Social Equity Fund, for example, notes that shareholder pressure on companies doing business with South Africa in the 1970s and '80s helped end apartheid.
But mainstream fund groups and the mutual-fund industry in general are fiercely opposed to the measure. They believe that the proposal would turn the mutual-fund industry into a political battleground, with fund decisions being based as much on political agendas as seeking financial gains for investors.
"This would be a complete invitation to politicize the mutual-fund process," says an industry insider with a mutual-fund trade group, who asked that his name be withheld out of concerns about business retaliation. "It would exert pressures on fund groups by people who wouldn't necessarily have the interests of shareholders at stake. A mutual fund is designed to make money for its investors. But fund managers would be looking over their shoulders at political issues instead."
"It is true that many funds do vote with management on key issues one of the complaints of the SRI people." the insider continues. "But at what point did it become wrong to vote with management?"
Those within the SRI movement counter that many fund groups vote with management to curry favor and obtain consulting or investment business, rather than simply on the merits of a particular issue.
SRI groups are especially critical of Fidelity Investments, the No. 1 provider of 401(k) plans at major US corporations. The company does not disclose its proxy votes, although it lays out its guidelines for voting decisions on its website (www.fidelity.com).
"We've long believed in quiet diplomacy with companies about proxy issues," says Vincent Loporchio, a Fidelity spokesman. The fund company, he says, votes on some 5,000 proxies every year.
"If we were to publicly announce that we have voted against management on some proxy issues, it could have a negative effect on the company's share price, which would negatively affect our own shareholders," Mr. Loporchio adds.
Still, the trend toward public disclosure of proxy voting is emerging. Besides Domini, Calpers, the California public employee pension plan, is now identifying its proxy votes.
Some observers also question whether the SRI movement can wield its sword of justice more accurately than it has in the past. After all, Enron was a stock darling of some SRI portfolios.
Other hot-button companies, including Adelphia Communications Corp., and Tyco International, also found their way into SRI funds. Still, SRI funds held far smaller positions in these firms than their more mainstream counterparts, and in several cases got out earlier.
"As we [the SRI industry] tighten our investment screens, we are better able to identify those companies that have the potential for problems," says Julie Fox Gorte, director of socially responsible research for the Calvert funds in Bethesda, Md.
Screening is "a very complicated process," says Val Dingle, director of marketing for Citizens Funds in Portsmouth. "We start by looking for companies with good investment possibilities. Then we add the social screen."
The fund company, she says, is now enhancing its screening process on corporate-governance issues.
Despite all the talk about corporate reform from the SRI industry, most SRI portfolios are not much different from those of many mainstream funds.
At Domini Social Equity Fund, for example, the No. 1 company in the fund's portfolio has been Microsoft, which in some political circles has been characterized as "domineering" and "manipulative." Other top companies within the Domini fund, as of Sept. 30, include Johnson & Johnson, American International Group, Coca-Cola, and Procter & Gamble.
Ms. Domini does not see such holdings as being out of place. "There is an opportunity for social investing to go more mainstream," she says, "by understanding that the screens are a useful tool in the understanding of corporate management."
Regardless, not all fund experts are enamored of SRI. Sheldon Jacobs, editor of No-Load Fund Investor, a newsletter, believes that investors should draw a line between their political and financial agendas.
Mr. Jacobs, a proponent of index funds, believes that socially motivated investors will do better by going with a broad-based index fund, even if it includes some undesirable companies. In that case, he says, take some of your earnings, perhaps the percentage linked to the "undesirable companies" and donate it to charity.
"Index funds also tend to protect investors through each company, in effect having a very small presence within the fund portfolio," adds Russ Kinnel, of financial information firm Morningstar Inc., in Chicago.
Of course, some SRI fund companies also offer "index" funds, although they are linked to a socially responsible index.
In general, SRI funds continue to tighten their screens. According to Barbara Krumsiek, who heads the Calvert Group, the nation's largest family of SRI funds, the company is now considering using screens related to business ethics as well as social issues.
Just last week, for example, Calvert booted several companies off its Calvert Social Index screen for questionable business practices.
Among them: Oracle. The company has serious unresolved questions about its accounting methods and political funding, as well as a number of pending lawsuits, says a Calvert spokeswoman. "That means that none of our funds can now include that company in their portfolios," she adds.
While SRI funds toughen their own standards, the fund industry as a whole is inching toward more of a traditional SRI approach, says Ms. Gorte.
Some mainstream fund companies have taken notice of the screening methods used by SRI funds, and now employ screens of their own. Pioneer, for example, uses a number of SRI screens for its funds, filtering out companies linked to tobacco, alcohol, and gambling.
Other fund groups that use screens include TIAA-CREF (avoiding military-weapons manufacturing and nuclear power firms, among others) and Dreyfus, whose Premier Third Century Fund seeks to include companies that pursue equal-opportunity employment.
Pimco's popular Total Return Bond Fund even has a version (called "No. 3") that uses some social-investment screens.
When it comes to performance, folks in the socially responsible investing industry are feeling pretty good these days.
At the least, they are likely feeling better than their counterparts in more traditional stock funds, many of which have sustained sharp losses in the past year.
SRI funds have been ahead of the broader stock market, as measured by the Standard & Poor's 500 index. (See chart.) While SRI funds as a whole are down along with the market, they have not fallen as sharply, in part, analysts say, because of the careful screening processes they use.
Many within the SRI industry expect their funds to stay ahead of the curve in the event of a stock market turnaround.
"Many SRI funds have a bias toward growth stocks," says Russ Kinnel, who heads equity analysis for information firm Morningstar Inc., in Chicago. SRI funds often reject old industrial firms found in many value funds. Many of these firms fail to pass SRI screens that deal with defense spending or pollution, for example. While value stocks tend to lead the economy out of recession, they have already had a major runup in the past year, Mr. Kinnel says. So growth stocks may rebound well in the next year, benefitting SRI funds.
Another reason SRI folks feel upbeat: Investors have been reluctant to yank money out of SRI funds. Net cash inflows to SRI funds have been up every month this year except July and September, according to Lipper Inc. By contrast, mainstream equity funds have had net monthly outflows every month since May.
"It's not surprising that SRI funds have done so well in attracting inflows," says Kathryn Barland, a senior research analyst with Lipper in Denver. "They are at the forefront of those issues now important to investors corporate governance, integrity, and ethics."