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Socially Responsible Investing Gets Active (and Passive)


Socially responsible investing has increasingly become hot over the past five years.

The growth is fueled by investors' desires to "marry the utilitarian and expressive characteristics of their investments,'' according to Sheldon McFarland, co-author of a new study, Three Hurdles to Implementing an SRI Mutual Fund Strategy.

McFarland is also vice president of Portfolio Strategy at Loring Ward, a San Jose, Calif.-based investment management shop,.

Lipper data indicates that the amount of assets held in SRI mutual funds over the past five years has grown from $44.4 billion to $50.6 billion. The number of socially-bent portfolios has risen from 142 to 156. Morningstar currently tracks 197 funds currently managing some $67 billion compared to $59.8 billion five years ago.

A Passive Approach

Unfortunately, McFarland noted that it is difficult to find sufficient diversification within the universe of such mutual funds, some times referred to as socially responsible investing funds.

His study of the 136 mutual funds within the Morningstar database found that the average fund investing in socially responsible U.S. companies contained only 127 stocks and the average such fund investing in international firms contained only 171 stocks.

Also, net operating expense ratios and fund turnover are high for socially-responsible strategies compared to an index or asset class strategy.

The study revealed that the average net expense ratio for all socially-oriented funds in the Morningstar database was 130 basis points, which is high when compared to the average index fund expense ratio of 50 bp.

The average turnover for a mutual fund investing in socially responsible companies is 67.80% per year, compared to 33.64% for the average index fund.

"Active management is going to underperform because of their higher fees and how lucky or unlucky their portfolios are is going to help/hurt their returns," said McFarland.

Loring Ward's passive SRI Global Series Portfolio Defensive Series, which invest in the Dimensional Fund Advisors US Social Core Equity 2 Fund and the DFA Emerging Markets Social Core Fund, is up .21% last year and the portfolio's Conservative Series dropped .83% versus 2.11% for the S&P 500. The fund charges a management fee of 25 bps and a net expense ratio of 35 bps. It bets on some 2,401 securities as of December 2011.

The Active Approach

Among active SRI funds, the $231 million Appleseed Fund's investor class returned -2.6% last year compared to 2.1% for the S&P 500 Index. But over a three-year period, the 5-star Morningstar fund retuned 17.8% versus the Standard & Poor's 500 return of 14.1% and 5.6% over a five-year period versus a -0.3% return for the S&P.

Sealed Air, which provides food safety and security, facility hygiene, and product protection services worldwide, Nabors, a land drilling contractor, and John B. Sanfilippo, were some of the fund's worst performers last year, according to the fund's latest shareholder letter. It's currently invested in between 20 to 25 names and sports a net expense ratio of 124 bps. It had a 74.4% portfolio turnover in 2011.

Portfolio manager Josh Strauss said that the 5-star fund will take its fair share of hits but argues that passive funds will have a tough time outperforming the market over the long haul and vice versa. "We will continue to take share and large funds will continue to give away shares," he said.

Why? Because index-hugging funds tend to stick pretty close to their indices, thus taking away the risks and rewards that stem from active management. Also, active managers' relatively smaller portfolios and higher turnover rates versus their passive counterparts mean that they're more nimble during times of volatility.

And as far as fees are concerned, Strauss said the fund is not expensive nor is it cheap. "No one is complaining to us about pricing."

However, not all active funds sport big price tags. For example, the $355 million San Francisco-based Parnassus Fund, which takes social, environmental and governance factors into account when investing in companies, charges a net expense ratio of 97 bps. The fund last year lost 5.01% versus the S&P but outgained the index over a five-year period to the tune of 17.93% versus 14.11%. The fund currently holds 31 names in its portfolio.

In his fourth quarter 2011 outlook, portfolio manager and founder Jerome Dodson acknowledged that the fund underperformed and lost money last year but said that he doesn't "think this means a permanent loss of capital for the fund, or for our shareholders who maintain a long-term approach to investing." The fund's top holdings include Finisar Corp., a supplier of fiber optic subsystems; Cisco Systemsand Intel.

Dodson doesn't plan on making major changes to the portfolio. "When the recovery strengthens, the portfolio should do very well," Dodson said.