A Fresh Look at Socially Responsible Mutual Funds

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

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8 Great Socially Responsible Funds

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Still, the Appleseed Fund gained 60 percent last year after losing just 18 percent in 2008. In many ways, Appleseed represents the traditional model for a successful SRI fund: It has delivered superior results despite, but certainly not because of, its screens. 

But increasingly, there are signs that a new generation of SRI funds is emerging, one that thinks of screens not as a net neutral or even as a potential hindrance but instead as a successful investing strategy. This new strain is perhaps most evident in the environmental arena, where the combination of innovation and a softening of public opinion has paved the way for funds to benefit from their focus on green investing. A recent survey by Allianz Global Investors, for instance, found that 71 percent of respondents see environmental technology as the next great American industry. 

[See Investors Say Environment Is Key for Economic Turnaround.] 

Then there are funds like Parnassus Workplace. On its surface, the fund's concern for strong workplace environments appears to be exclusively ethical. But in reality, Dodson's decision to invest only in those companies that provide superior conditions for workers is much like the choice a manager would make to buy a stock only if it's trading at a certain valuation. In other words, it's a self-imposed restriction, but one that is ultimately aimed at making money. "If you have a happy workforce—people that like the company, that feel they're being treated fairly—I think they're going to work harder. And in today's economy . . . you really need a motivated workforce," says Dodson. 

Accidentally on purpose. It goes without saying that most large-cap funds, regardless of the talent of their management, will get a boost when blue chips rally. Meanwhile, if big-name stocks fall out of favor, there is little that a large-cap fund can do to buck the trend. The same goes for sector funds when a given type of investment is either rising of falling. 

Surprisingly, investors tend to overlook the fact that similar dynamics influence SRI funds. In other words, even if they are not explicitly sector-specific investments, SRI funds are often driven toward or away from certain parts of the market by the nature of their screens. 

In 2008, for example, Amana Trust Income (AMANX) made the superficially prescient move of completely avoiding financials. And as financial stocks tanked and battered the returns of Amana's competitors, the fund easily made it into the top percentile of Morningstar's large-value category that year. But unlike its solid long-term track record, which points to talented management, Amana's avoidance of financials doesn't at all suggest that the fund's analysts had an inkling that the sector would tank. Instead, since Amana Trust Income is an Islamic fund, it is barred from investing in banks regardless of how well or poorly they are performing. 

Similarly, the Ave Maria funds, which cater to Christian investors, are not allowed to own "companies that support abortion in any way," says comanager George Schwartz. This keeps the funds away from a number of hospitals and insurance providers and also translates into what is for all intents and purposes a blanket ban on pharmaceutical companies. Over the past few years, this avoidance of pharmaceuticals has generally helped Ave Maria's stock funds. "We did better by not having those in the funds," says Schwartz. 

These accidents of chance are perhaps even more likely to materialize in the future as SRI funds begin to screen not only for the absence of certain factors but also for the presence of others. The Appleseed Fund is a prime example. Apart from screening out objectionable industries, management likes to make sure that most of the companies it owns actively promote environmental protection, human rights, and community investment. 

"You traditionally think of social screening . . . as them coming up with a list of things that they can't own—like alcohol, tobacco, gambling stocks, weapons stocks, or things like that," says Kathman. "But there's been this tendency among a lot of SRI funds in recent years to have it be more positive screening, where they're looking for companies that have these positive attributes that they want to see."