Geoff Wisner

Socially Responsible Investing at Cutter

Before this year's company meeting, some of you indicated that you might like to see a socially responsible fund included in our 401(k) plan.

I'd like to see this happen too, but like all good things it would come with a price tag: in this case, about $1,700 per year. Because our funds currently all come from Vanguard, and Vanguard doesn't offer a socially responsible fund, we would have to upgrade our plan from a one-family system to one that would allow funds from two or more families. Is it worth it? Below are my attempts to answer questions that might influence this decision.

What makes a fund "socially responsible"?

Every fund makes its own decisions about what it considers socially responsible. Some funds exclude all companies in "dirty" industries such as chemicals, while others try to pick the cleanest companies within those industries.

The Domini Social Equity fund, for example, excludes alcohol, tobacco, gambling, weapons, and nuclear power (but not animal testing). All the companies it owns, which include about half the S&P 500, are judged to have "positive records in the areas of workplace diversity, employee relations, the environment, and the social impact of their products." However, the fund still owns certain companies -- such as McDonald's, Microsoft, Wal-Mart, and Disney -- that have been criticized for various environmental or business practices.

Isn't this a pretty inconsistent system?

Yes. But I don't think that invalidates it. Each of us has a somewhat different interpretation of what is moral and ethical, but most of us would agree that some working definition is better than none at all.

Wouldn't it be dangerous to put all my investments in just one or two socially responsible funds? And if I invest in regular funds too, isn't that inconsistent?

Yes, you might not want to put everything into a single social fund, especially since they generally include only US stocks, and their performance as a group has been uninspiring. And yes, it would be inconsistent to invest in regular funds as well. But then again, it might be inconsistent for you to give money to Friends of the Earth while driving a car, using an air conditioner, eating meat and wearing leather. It's up to you to decide just how moral you can afford to be.

Aren't there any socially responsible foreign stock funds?

Hardly any. Of the 40 socially responsible funds listed in the August issue of Mutual Funds magazine, only Calvert World Value International Equity "A" is a foreign stock fund, and only Citizens Global Equity is a global fund (i.e., it buys both US and foreign stocks). Of these two, only the Calvert fund has a 3-year performance record, and it's done slightly worse than the average international fund. One reason for the lack of social funds with foreign exposure is that it's difficult to get information on the practices of companies overseas.

Does this mean I shouldn't invest any money in foreign stocks?

Kate recently showed me an article from the Atlantic Monthly that argued that by investing overseas, particularly in emerging-markets funds, Americans are sharing in profits derived from environmental and human rights crimes caused by strip mining, clear-cut logging, sweatshop assembly factories, and so on.

This prompted me to take a look at the companies held by our Vanguard emerging-markets fund. As of 12/31/96, the 20 major holdings included a lot of banks and telecommunications companies, with a couple of companies in potentially destructive lines of business: De Beers (diamond mining) and Petrobras (oil). Altogether the fund had 31% in financial stocks (banks, etc.), 18% in industrial cyclicals, 17% in services, and 11% in utilities. Not too bad. (Then again, one could dig deeper and ask who these banks are lending their money to, and what are they doing with it? Banks themselves have begun asking these questions, as they recognize that certain practices make companies bad business risks.)

Of course, many dubious activities in developing countries, like those of Shell Oil in Nigeria, are carried out by multinational corporations based in the US or Europe, and not necessarily represented in emerging-markets funds.

In addition, it's worth remembering that developing countries, whether democratic or not, need foreign exchange to buy goods and services from the rest of the world so they can continue to develop and improve the standard of living of their people. If they don't get money from private investors like us they may turn to institutions like the IMF and the World Bank, which typically demand a "restructuring" of a country's economy. Under restructuring, currencies are devalued, export agriculture is encouraged at the expense of domestic food production, and food subsidies are cut, causing greater hardship for the poor.

Do "bad" companies really care if we own their stock or not?

Probably not very much. Socially responsible funds make up a fraction of one percent of the fund universe, so Philip Morris is probably not very worried if the Calvert funds refuse to buy its stock. On the other hand, being publicly shunned is a source of negative publicity that could have some effect.

Haven't social funds performed rather poorly?

On average, yes. Mutual Funds notes that "the ten socially screened equity funds with five-year track records fall short of their peer-group returns (based on investment objective) by a cumulative 22% (76% versus 98%) since mid 1992, with only two funds beating their peer groups." However, it points out that these results have been skewed by "missteps" at funds like Pax World and Parnassus, and the "tragic" performance of the Calvert funds.

Some argue that by limiting the number of funds a manager can choose from, you will inevitably limit profits. Yet almost every fund has its specialty (large-cap growth, small-cap value, etc.) and this specialization sometimes provides an advantage in performance. What's more, the Domini 400 -- an unmanaged index of socially responsible companies -- has performed even better than the S&P 500 since its creation in June 1991: 224% versus 195%. This would suggest that the problem is with fund managers picking the wrong stocks, rather than with the "good guys" finishing last.

Are the managers of socially responsible funds less competent than those of regular funds? There are so few of these funds that it's hard to say for sure. In the end, though, it doesn't matter so much how well the social funds have done on average; all you need is one good one.

What if I just invest for maximum profits, and use some of the money I make to support the causes I favor?

You can certainly do that -- and if you believe that social funds inevitably make less money than regular ones, this approach makes some sense. But if you can find a way to do well by doing good (the usual cliché in articles on this subject),why not do it?

What's the best socially responsible fund?

As I said at the annual meeting, my vote for the best social fund goes to the Domini Social Equity fund, on the basis of strong performance plus positive social leverage.

Morningstar recently said, "More than any other similarly focused fund, this offering, and the index it mimics, has demonstrated that so-called socially responsible investing can deliver competitive returns." The fund currently has a four-star rating (above average) from Morningstar, and so far this year it is outperforming the Vanguard Index 500.

The Domini Social Equity fund is based on the Domini 400 index, mentioned above, and therefore benefits from index-fund virtues such as low turnover and relatively low expenses (its current expense ratio is 0.98%). And because it hangs onto stocks for long periods, Domini is able to sponsor shareholder resolutions. In this way, the fund not only shuns the bad guys, but it applies pressure to the good guys to do even better.

Published in Bread and Cutter, September/October 1997.



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Geoff Wisner Socially Responsible Investing at Cutter Before this year's company meeting, some of you indicated that you might like to see a socially responsible fund included in our 401(k) plan. I'd like to see this happen too, but like all good things it would come with a price tag: in this case, about $1,700 per year. Because our funds currently all come from Vanguard, and Vanguard doesn't offer a socially responsible fund, we would have to upgrade our plan from a one-family system to one that would allow funds from two or more families. Is it worth it? Below are my attempts to answer questions that might influence this decision. What makes a fund "socially responsible"? Every fund makes its own decisions about what it considers socially responsible. Some funds exclude all companies in "dirty" industries such as chemicals, while others try to pick the cleanest companies within those industries. The Domini Social Equity fund, for example, excludes alcohol, tobacco, gambling, weapons, and nuclear power (but not animal testing). All the companies it owns, which include about half the S&P 500, are judged to have "positive records in the areas of workplace diversity, employee relations, the environment, and the social impact of their products." However, the fund still owns certain companies -- such as McDonald's, Microsoft, Wal-Mart, and Disney -- that have been criticized for various environmental or business practices. Isn't this a pretty inconsistent system? Yes. But I don't think that invalidates it. Each of us has a somewhat different interpretation of what is moral and ethical, but most of us would agree that some working definition is better than none at all. Wouldn't it be dangerous to put all my investments in just one or two socially responsible funds? And if I invest in regular funds too, isn't that inconsistent? Yes, you might not want to put everything into a single social fund, especially since they generally include only US stocks, and their performance as a group has been uninspiring. And yes, it would be inconsistent to invest in regular funds as well. But then again, it might be inconsistent for you to give money to Friends of the Earth while driving a car, using an air conditioner, eating meat and wearing leather. It's up to you to decide just how moral you can afford to be. Aren't there any socially responsible foreign stock funds? Hardly any. Of the 40 socially responsible funds listed in the August issue of Mutual Funds magazine, only Calvert World Value International Equity "A" is a foreign stock fund, and only Citizens Global Equity is a global fund (i.e., it buys both US and foreign stocks). Of these two, only the Calvert fund has a 3-year performance record, and it's done slightly worse than the average international fund. One reason for the lack of social funds with foreign exposure is that it's difficult to get information on the practices of companies overseas. Does this mean I shouldn't invest any money in foreign stocks? Kate recently showed me an article from the Atlantic Monthly that argued that by investing overseas, particularly in emerging-markets funds, Americans are sharing in profits derived from environmental and human rights crimes caused by strip mining, clear-cut logging, sweatshop assembly factories, and so on. This prompted me to take a look at the companies held by our Vanguard emerging-markets fund. As of 12/31/96, the 20 major holdings included a lot of banks and telecommunications companies, with a couple of companies in potentially destructive lines of business: De Beers (diamond mining) and Petrobras (oil). Altogether the fund had 31% in financial stocks (banks, etc.), 18% in industrial cyclicals, 17% in services, and 11% in utilities. Not too bad. (Then again, one could dig deeper and ask who these banks are lending their money to, and what are they doing with it? Banks themselves have begun asking these questions, as they recognize that certain practices make companies bad business risks.) Of course, many dubious activities in developing countries, like those of Shell Oil in Nigeria, are carried out by multinational corporations based in the US or Europe, and not necessarily represented in emerging-markets funds. In addition, it's worth remembering that developing countries, whether democratic or not, need foreign exchange to buy goods and services from the rest of the world so they can continue to develop and improve the standard of living of their people. If they don't get money from private investors like us they may turn to institutions like the IMF and the World Bank, which typically demand a "restructuring" of a country's economy. Under restructuring, currencies are devalued, export agriculture is encouraged at the expense of domestic food production, and food subsidies are cut, causing greater hardship for the poor. Do "bad" companies really care if we own their stock or not? Probably not very much. Socially responsible funds make up a fraction of one percent of the fund universe, so Philip Morris is probably not very worried if the Calvert funds refuse to buy its stock. On the other hand, being publicly shunned is a source of negative publicity that could have some effect. Haven't social funds performed rather poorly? On average, yes. Mutual Funds notes that "the ten socially screened equity funds with five-year track records fall short of their peer-group returns (based on investment objective) by a cumulative 22% (76% versus 98%) since mid 1992, with only two funds beating their peer groups." However, it points out that these results have been skewed by "missteps" at funds like Pax World and Parnassus, and the "tragic" performance of the Calvert funds. Some argue that by limiting the number of funds a manager can choose from, you will inevitably limit profits. Yet almost every fund has its specialty (large-cap growth, small-cap value, etc.) and this specialization sometimes provides an advantage in performance. What's more, the Domini 400 -- an unmanaged index of socially responsible companies -- has performed even better than the S&P 500 since its creation in June 1991: 224% versus 195%. This would suggest that the problem is with fund managers picking the wrong stocks, rather than with the "good guys" finishing last. Are the managers of socially responsible funds less competent than those of regular funds? There are so few of these funds that it's hard to say for sure. In the end, though, it doesn't matter so much how well the social funds have done on average; all you need is one good one. What if I just invest for maximum profits, and use some of the money I make to support the causes I favor? You can certainly do that -- and if you believe that social funds inevitably make less money than regular ones, this approach makes some sense. But if you can find a way to do well by doing good (the usual cliché in articles on this subject),why not do it? What's the best socially responsible fund? As I said at the annual meeting, my vote for the best social fund goes to the Domini Social Equity fund, on the basis of strong performance plus positive social leverage. Morningstar recently said, "More than any other similarly focused fund, this offering, and the index it mimics, has demonstrated that so-called socially responsible investing can deliver competitive returns." The fund currently has a four-star rating (above average) from Morningstar, and so far this year it is outperforming the Vanguard Index 500. The Domini Social Equity fund is based on the Domini 400 index, mentioned above, and therefore benefits from index-fund virtues such as low turnover and relatively low expenses (its current expense ratio is 0.98%). And because it hangs onto stocks for long periods, Domini is able to sponsor shareholder resolutions. In this way, the fund not only shuns the bad guys, but it applies pressure to the good guys to do even better. Published in Bread and Cutter, September/October 1997.