A Fresh Look at Socially Responsible Mutual Funds

Do morality screens harm performance? When can a socially responsible fund outperform the market?

A dollar bill growing on a tree.

8 Great Socially Responsible Funds


 Most socially responsible mutual funds are born of a desire to help the environment, slow the spread of violence, or boycott certain practices. Parnassus Workplace (PARWX), on the other hand, sprang from between the covers of Fortune magazine. 

Several years ago, Jerome Dodson, who founded Parnassus Investments in 1984, stumbled upon an interesting tidbit: The stocks of publicly traded companies that made Fortune's list of the "100 Best Companies to Work For" tended to perform exceptionally well. 

[Slide Show: 8 Great Socially Responsible Funds.]

Operating under that premise, Dodson launched Parnassus Workplace in 2005. Since then, the fund, which invests exclusively in companies that treat their employees well, has consistently trounced the competition, and it is currently the top-ranked fund in U.S. News's recently unveiled mutual fund rankings

[Use the U.S. News Mutual Fund Score and the rankings of trusted fund analysts to find the best mutual funds for you.] 

A number of other socially conscious funds join Parnassus Workplace atop the U.S. News rankings. Taken together, these funds hint at a shifting landscape for socially responsible investing (SRI), even as the debate rages on over the wisdom of mixing morality with stock picking. 

All too often, it seems, this debate moves toward the extremes. Socially responsible investors, for example, are portrayed either as clueless amateurs or forward-thinking geniuses. And their portfolios, in turn, are labeled as everything from hopelessly restrictive to deceptively insightful. 

In the process, the most fundamental of questions often go unanswered: Do social screens harm performance? Under what circumstances will a socially responsible fund outperform the market? And what changes are on the horizon for this style of investing? 

The numbers. Broadly defined, socially responsible funds can focus on anything from religion to the environment to pacifism. By style, they can invest in large-cap stocks, small-cap stocks, bonds, and anything in between. Given this wide range, there's no ideal way to track the performance of SRI funds as a group. 

Still, there are some adequate proxies. A U.S. News analysis of funds classified by Morningstar as socially responsible shows that they lost 32 percent in 2008 and were up 28.4 percent in 2009. By comparison, the S&P 500 shed 38.5 percent of its value in 2008 and rose by 23 percent in 2009. Meanwhile, the Social Investment Forum, a trade group for SRI investors, found in an analysis of 160 socially responsible funds that 65 percent outperformed their benchmarks in 2009. 

A final way to quantify the performance of SRI funds is through measures like the FTSE KLD 400 Social Index, which tracks the returns of stocks that are attractive to investors concerned about environmental, social (excluding religious), and governance issues. The index has one-, three-, and five-year returns that beat the S&P 500. 

At the same time, there are a number of far less positive indicators for SRI funds. Alternative energy funds, for instance, got crushed in 2008 and generally didn't rebound nearly enough last year to erase the damage. 

A new model? David Kathman, a Morningstar analyst who covers SRI funds, often gets asked if they are capable of beating the market. "They certainly can [outperform], because there are some that have really good records," he says. "The question is whether that's despite their social screening or because of it or just not directly related to it." 

Common wisdom holds that the more restrictions a fund has, the more difficult it is for it to consistently perform well. By that measure, SRI funds, which aim to screen out not only financially unsound investments but also investments that are socially or ethically objectionable, start at somewhat of a disadvantage. "There are certainly investments that could generate a strong financial return that we've taken a pass on," concedes Adam Strauss, a comanager of the Appleseed Fund (APPLX), which avoids companies in the tobacco, alcohol, pornography, gambling, and weapons industries.