A recent conversation on the Motley Fool Hidden Gems discussion boards got me thinking: Are we as investors responsible for the negative effects of our companies' products? For example, should investors own online casino operator CryptoLogic (NASDAQ:CRYP) when uncontrolled gambling is a problem in our society? If you've pondered similar questions, you may have considered investing in "socially responsible" mutual funds. Your heart may be in the right place -- but should it have a place in your investing strategy?
A quick overview
Socially responsible investing (SRI) is a growing trend among investors. It screens companies based on their value and worth, then applies an investor's personal values, morals, and/or beliefs to the remaining choice of investments.
For example, environmentalists probably aren't fans of the mining practices of Alcoa (NYSE:AA) and MittalSteel (NYSE:MT). Health-conscious investors may consider Anheuser-Busch (NYSE:BUD) and Altria (NYSE:MO) unworthy for profiting from products like alcohol and tobacco. Nuclear energy, weapons, and gambling can also fall into these sorts of negative screens.
Then there are the positive SRI screens. Does a company respond to shareholder activism? Does it have a good reputation within communities? Wal-Mart might have some trouble here. Does the company have a clean(ish) history regarding human rights? Nike's past performance might raise a few red flags. What about a company's employment and labor practices, or their products and services? If a company doesn't score well here, then it probably wouldn't pass an SRI screen.
Yes, but do they make money?
SRI has been around for a long time, but it's only grown into a large, serious sector in the last 20 years. There are now a number of mutual funds that choose their investments based on at least some of the criteria above.
For example, the Winslow Green Growth Fund (FUND:WGGFX) picks companies with good environmental records and avoids those dealing with nuclear energy. In contrast, a stricter fund like MMA Praxis Intermediate Income A (FUND:MIIAX) "screens against alcohol, tobacco, gambling, abortion products, nuclear energy, and weapons manufacturing," as well as animal testing. It looks for companies with positive records of achievement in the environment, human rights, and other issues.
Returns from these funds vary greatly. Of the six dozen or so that I examined, the best had an annualized return from inception of 13.72% (November 1986) -- not too bad, especially over 19 years. The worst had minus 5.68% annualized returns from inception (August 1999). All but three trailed the S&P 500 index over their lifetimes. Don't let those numbers fool you, though. All I did was highlight the best and worst of the funds I looked at. The same kinds of numbers can be found among "traditional" funds.
The wisdom of choosing only SRI-favorable companies for investing is hotly debated. Most studies conclude that there is no statistically significant difference in the performance of SRI and non-SRI funds. Still, remember that this data is far from "clean." As one study I read pointed out, it's tough to statistically model questions like this without introducing human biases.
The perils of SRI
I see three problems with the practice. First, SRI brings emotions into investing decisions. Second, it might be tough for investors to accurately determine which companies best reflect their values. Third, SRI alone doesn't meet my own definition of being socially responsible.
It's only too human to want to "punish" companies you don't like by not investing in them. But consider this: The company doesn't care. Your failure to invest in Wal-Mart won't influence its business practices. It's about as effective as refusing to vote in an election because you don't like the incumbent's policies.
Besides, basing your investments on emotion can lead you to some weird places. Suppose you're a die-hard environmentalist opposed to mining companies' practices. Does that mean you'll boycott any product made with metal? Where do you draw the line? As author Robert Heinlein wrote, "Just bear in mind that a person who eats meat is on the same moral level as the butcher."
The best way to take action
Some SRI investors will argue that your part-owner status makes you responsible if your company sells harmful products. That just doesn't wash with me. I own shares in Anheuser-Busch, for example. Does that make me responsible for a drunken driver who causes a fatal accident? I have to assume that the people who buy my company's products are adults, capable of making their own choices. I shouldn't be held responsible for someone else's decision, or its consequences.
Socially responsible investing lets us pat ourselves on the back, assured that we're doing something good. But simply putting money in a fund does nothing to get us involved with the actual issues that affect our world; it just helps us avoid them.
If you truly want to be socially responsible, get involved and do something. Lobby your state or federal representatives to ban smoking in public places, or donate money or volunteer for agencies such as MADD. Organize a boycott of a company's products. Be an activist shareholder; write to the board of directors and vote your shares at the annual meetings.
That's one area where I can see a benefit to SRI. Where individual investors might not have much power to change a company's policies, SRI funds offer one way to group together hundreds or thousands' of investors' money and influence to actively lobby for change. Shareholder activism, from both SRI and non-SRI funds and groups, has helped to push many companies to become friendlier to their communities or the environment.
Investing is hard enough as it is. Like anything worth doing, it takes a lot of work and some tough decisions. It doesn't make sense to me to handicap yourself from the get-go by eliminating hundreds, if not thousands, of companies from your possible investments. You'll be gaining no real advantage, inviting plenty of confusion, and ignoring better ways to solve social problems.
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Got an opinion on SRI? Stop by our Socially Responsible Investing board .
Cryptologic is a Motley Fool Hidden Gems pick. Anheuser-Busch is a Motley Fool Inside Value pick.
Fool contributor Jim Mueller owns shares in Cryptologic and Anheuser-Busch, but none of the other companies mentioned here. He has said that he would not buy shares in tobacco firms because cigarette smoke affects his allergies. That might not make sense, but it's all according to the Fool disclosure policy .well, except for the allergy part.
