Concerns About SRI Funds

While we wish it otherwise, existing SRI funds have struggled to keep pace with the wider market. Compared to our low-cost indexing strategy, SRI funds are more expensive, have historically underperformed, and are not well diversified.  We support SRI, but want our members to be cognizant of the tradeoffs.

1. SRI funds are typically actively-managed funds, and thus are more expensive.

   Actively-managed funds need to hire a Portfolio Manager to screen their investments, and the fund tends to buy and sell securities fairly often.  Thus we are paying for that additional labor and “skill” in stock-picking, as well as transaction costs. SRI funds will actively modify which companies meet specific environmental, social, and governance criteria.  This is in contrast to passive index funds, which have a lower cost because they just buy and hold the vast majority of a given broad market index (e.g. the S&P 500).

   While a low-cost index fund will typically charge only 0.18% in fees, most SRI funds charge 1% to 2% in fees.  This is not a small matter. If you invested $10,000 for your retirement, you would pay less than $500 in fees over 10 years in a low-cost index fund. But if you have placed it in an SRI fund charging 1.5%, you would have paid $4,500 in fees!  Note that this isn’t just a feature of SRI funds. Many actively-managed funds have similarly high fees.  Don’t believe us? Check out your 401k options.

2. SRI funds have historically underperformed.

   While Vanguard’s Total Stock Market Index Fund would have given you a 10-year annualized return of 3.6%, you would only have gotten 0.9% from its FTSE Social Index Fund.  Calvert’s Social Index Fund also underperforms, returning only 0.6% to its investors over the same period.  Both social index funds also underperform in the one, three, and five year return measurements.  Vanguard’s Total International Stock Index Fund returned a decent 6.4% over the past 10 years, while Calvert’s International Equity Fund provided an underwhelming 1.1% over the same time period.  Calvert’s SRI bond portfolio similarly underperforms compared to a low-cost bond market index fund. That said, past performance is not a good indicator of future performance.

3. SRI funds are not well diversified.

   Let’s assume that your primary purpose for investing is to save for retirement.  We typically recommend that Community Ladders’ members gain exposure to a broad swath of the stock market, generally through low-cost index funds.  Thus, the natural starting point for investing in a diversified portfolio of companies is a broad market portfolio (like the S&P 500) or a lifecycle fund.  These will include companies from every industry.  By screening out companies, as SRI funds do, the investable universe becomes smaller.  This can lead to either over- or under-performance, but concentrating in some industries while excluding others increases the inherent risk in your investment.

   After conducting negative screens (which tend to screen out extractive industries, pharmaceuticals, and gambling and liquor companies), most SRI funds tend to be heavily weighted towards the financial and information technology sector. The recent financial crisis offers clear evidence of the risks involved in overweighting one sector while excluding others.

4. SRI funds may invest in unstable companies.

   For example, one can invest in Calvert’s Global Alternative Energy Fund. Personally, I think it’s really exciting to be promoting companies that are investing in solar, wind and all the good stuff needed to reduce our reliance on foreign oil and combat climate change. But companies in the alternative energy sector face cut-throat competition, with many of them failing as new technology evolves faster than they can raise money and adapt. Partly because of this, Calvert’s Alternative Energy Fund lost 26% of its value over the past three years.

The concerns we list here are real and important, but they are not a call to abandon SRI investments. We are mainly concerned with making sure that members are making an informed choice about SRI; this includes both the awesome, and the decidedly not-so-awesome, parts.