What Happened to Socially Responsible Funds?

December 2014

Most of our clients are familiar with socially responsible investing, an approach to investment management that focuses on investing in companies that meet certain social and ethical criteria. What makes this option particularly unique is that, while it still aims to grow assets, it emphasizes social responsibility over high returns. When managing these types of accounts, we use socially responsible mutual funds. In the roughly 30 years since socially responsible investing became a broad movement, there have been three general phases, each dictating a different approach to how fund managers build socially responsible funds. As a firm offering socially responsible investment portfolios, we have strong feelings about the state of the movement and its effect on our clients.

For the first half of its existence, socially responsible fund managers would develop a set of criteria to define what made a company socially responsible and then seek out stocks of companies that fit that definition to include in their fund. For instance, a socially responsible company could be one that only used sustainable resources, directly supported its local community, or had high standards for consumer and human rights. Once a fund manager found a company that met these criteria and fully researched it, it could be added to the list of acceptable companies in which to invest. This “inclusionary” approach made sure that only the most socially responsible companies made it into funds. This method was good for maintaining social responsibility, but it was difficult to build balanced portfolios one company at a time and could significantly compromise portfolio diversity and growth.

In response to this problem, roughly 15 years ago the socially responsible mutual fund industry shifted into a second phase, which moved away from inclusion and focused instead on exclusion. With this model, fund managers built funds as they normally would and then weeded out stocks of companies that didn’t meet certain criteria. The general benefit to this approach was that it allowed managers to draw from a much larger pool of companies, which often led to more balanced portfolios with higher growth potential.

A significant downside to this second phase, the “exclusionary” approach, was that it was difficult and expensive to implement. All investments in a fund still needed to be exhaustively researched, which took considerable time and skill. The other drawback was that most of the recent, large-scale growth in the financial markets, as a whole, was in the oil and gas industry, which was almost completely excluded from all socially responsible investment models. In the past few years, socially responsible fund managers watched others managing non-socially responsible funds reap large gains, while their own portfolios had much more modest returns.

This led to the current, third phase of socially responsible investing, which we call the “best-in-class” approach. In the current environment, most fund managers seek to remain socially responsible while also tapping into the growth potential of all industries, including ones like oil and gas. This current method involves drawing investments from a broad range of industries. Then, all possible investments are ranked within their industry by how socially responsible they are based on similar criteria to the prior approaches. The difference is that the best companies from each industry (or the least terrible companies) get included in the portfolio regardless of their objective social responsibility. By using this method, socially responsible funds now hold stocks from industries like oil and gas or defense and benefit from their growth potential. This is because they are investing in companies that are subjectively more socially responsible (or not quite as irresponsible) compared to others in the same industry, rather than judging the companies against established objective standards for social responsibility.

At Robasciotti & Associates, Inc., we strongly disagree with how most funds are now approaching socially responsible investing and believe the best-in-class approach is greenwashing in its highest form. We fail to see how it is possible to have a socially responsible fund if it includes companies that are socially irresponsible. We believe that socially responsible investing is about building the right portfolio based on the social and ethical principles of our clients, rather than building a portfolio that includes the least irresponsible companies in a particular industry. Therefore, when building our client portfolios, we continue to use more stringent definitions of social responsibility than the industry as whole.

We keep a close watch on the socially responsible investment world and are actively engaged in efforts to reform the best-in-class approach. At the same time, we offer and continue to find solutions for investors still committed to the exclusionary model. As always, we approach investment strategies from a holistic view of your needs and your goals, whether that’s socially responsible, conventional, or somewhere in between.