You are finally filling out your 401k form to maximize that employer match that Bill told you about. You check the box next to the Social Index Fund. You are concerned about the environment and public health, and it feels right that your retirement money is invested in socially responsible companies.
But look again! That social index fund you just chose actually owns McDonald’s, which you have an issue with because the company continues to advertise to children and get them hooked on unhealthy food. Its third largest holding is JP Morgan Chase, a major player in pushing those nasty derivatives that amplified risk in our economy – a major contributing factor to the 2008 financial crisis. This is social responsibility?
Socially responsible investing is not a new phenomenon (though it certainly has become more popular as of late). The earliest proponents were institutional investors with religious affiliations that opposed holding companies involved with alcohol, tobacco, and gambling. As time went by, socially conscious investors increasingly sought to incorporate women’s rights, labor issues, health, the environment, and indigenous peoples’ rights into their investments. Since then, a formidable list of environmental, social, and governance requirements (“ESG”) has emerged.
As of 2010, there were 250 socially screened mutual fund products in the U.S., each of them with their own screening criteria. Funds usually have negative screens. Starting from, say, a universe of 3,000 companies, they screen out companies in certain industries (e.g. armaments, nuclear energy, and pharmaceuticals). Some funds perform positive screens. Starting with zero number of companies, they add those which demonstrate leadership in climate change, have strong labor codes, or have diverse independent boards. There are even funds dedicated to very specific niches, such as alternative energy or water.
However, many SRI funds have vague screening criteria, which can allow in some questionable companies. The fund may say it invests in companies with over $10 billion in market capitalization with “environmentally sound policies.” But what are those, and how rigid is their screening process? Some funds say they “consider a company’s performance with respect to environmental responsibility, labor standards, and human rights,” but you’ll really need to dig to figure out what that means.
An SRI fund’s selection criteria may not match your ethical requirements. Value SRI funds, for instance, may take ESG factors into consideration during its investment process, but may nonetheless decide that the current market price of a stock is so undervalued that the potential out-performance significantly offsets the company’s poor corporate citizenship (fund managers, after all, are rewarded based on performance). Another example, particularly appropriate during these times of fiscal crisis, is financial companies. An SRI fund may include a particular bank because it provides a product that serves lower income individuals. But what if that same bank’s subsidiary has been providing predatory loans to the same low-income group (this is actually quite a common scenario)?
The main point here is that you’ll want to examine closely the holdings of the SRI fund you are considering to be sure it truly meets your ethical criteria. As we note in other blog posts, SRI investing entails some sacrifices, so it behooves you to make sure you are sacrificing for the reasons you intended.
Alvin Carlos oversees the finances of a social justice organization in Washington DC. He is a Financial Adviser at Community Ladders.
Tec Han manages investments for Clark Enterprises, the parent company of Clark Construction. He is Director of Financial Planning and Training at Community Ladders.
