Good Deeds Deliver

Dec. 21, 2004
Socially responsible investing reaps ethical and financial rewards.

The term "socially responsible investing" may call to mind images of tree-hugging, granola-munching, fur-slashing throwbacks to the 1960s. However, investors who base their decisions on a company's social and environmental policies have moved into the mainstream. Socially responsible investing now captures one out of every eight investment dollars in the U.S., and accounts for more than $2 trillion in investment assets under management, reports the Social Investment Forum, a Washington D.C.-based industry organization. These socially conscious investors are a force to be reckoned with, and manufacturing executives ignore them at their peril, says Christopher Luck, a partner with First Quadrant LP, a money-management firm in Pasadena, Calif. Just what is socially responsible investing? Broadly speaking, it refers to strategies of investors who want their money to earn a return and also create positive social change, says Peter D. Kinder, president of Kinder, Lydenberg, Domini & Co. Inc., a Boston-based research firm. Of course, given our diverse society it's impossible to find a universally agreed-upon agenda for social change. Historically, many funds have stayed away from the so-called "sin stocks" -alcohol and tobacco manufacturers and companies in the gambling industry. Today, however, a number of funds are moving away from simply excluding stocks of companies in certain industries. Instead they are looking at companies across most industries that boast strong environmental and social performance records, says Paul Hilton, a New York-based manager of Dreyfus Corp.'s $2.5 billion Premier Third Century Fund. "It turns the performance argument on its head," says Hilton. Rather than excluding companies that are involved in something that's morally objectionable to a few investors, the funds are looking for companies that are leaders in employing environmentally and socially responsible practices. Their leadership in these areas also can enhance their financial performance. Healthy Returns The modern era of socially responsible investing in the U.S. began with a few funds that were created in the politically charged 1960s. In the last several years the strategy has taken off. Between 1997 and 1999 socially responsible investments grew by 82%-nearly double the growth in the market overall, reports the Social Investment Forum. One reason for the growth: These investments have been a great way to make money. Consider the Dow Jones Sustainability Group Index (DJSGI), which tracks the performance of 236 companies from the broader Dow Jones Global Index. The companies in the DJSGI have superior records in terms of incorporating responsible economic, social, and environmental behavior into their business strategy. The DJSGI boasts an annualized return of about 28% over the last five years. That compares with a 23% annual return for the broader Dow Jones Global Index. The recent performance of socially responsible funds runs counter to previously held wisdom that investors seeking to do good with their money have to be satisfied with lower returns, and that corporate management's raison d'tre is to maximize shareholder value. Socially responsible actions, which often divert resources and money from the bottom line (at least in the short-term), would run counter to this mandate. Yet, especially in environmental matters, the link between socially responsible practices and shareholder returns is becoming evident. That's because a company's ability to deal successfully with environmental issues can be a credible measure of management quality, which is notoriously tricky to gauge, contends Frank Dixon, managing director with Innovest Strategic Value Advisors, New York. Management teams that excel in handling environmental issues, which come with a morass of technical, market, and regulatory problems, are likely to do a good job overall, says Dixon. In fact, Innovest's research has shown that stocks of companies with above-average environmental performance outperform their competitors by three to 25 percentage points annually. Dixon explains, "The concept of fiduciary responsibility is beginning to change, to consider that environmental and social factors are relevant to the bottom line." Still, determining precisely what determines any fund's performance isn't cut and dried. First Quadrant's Luck notes that when investors are considering socially responsible funds, the returns depend on the stock-picking skills of the managers, as well as the fact that the fund is socially responsible. That's why Luck has used the Domini 400 Social Index in his own research. Rather than pick certain firms from the universe of companies considered socially responsible, the Domini 400, like any index fund, defines in advance the criteria used to determine which companies will be included. Even without actively picking stocks, Luck notes, since its inception the Domini 400 consistently has beaten the S&P 500. Luck's research has shown that about one-half of the Index's above-average performance can be attributed to the types of stocks that are chosen for it. For instance, technology stocks, which have done well over the past decade, account for about 13% of the Index. However, Luck attributes the other half of above-average performance to the socially responsible environment at the companies. Management Ally? Publicly traded companies increasingly are going to have to consider socially responsible investors. For starters, anecdotal evidence suggests that young people are a big part of the growing popularity of these types of investments. "I'm surprised at how importantly younger employees view environmental responsibility where they work," says Thomas Hellman, vice president and corporate product quality officer with pharmaceutical giant Bristol-Myers Squibb Co., New York. What's more, socially responsible investors can be management's allies, contends Amy Domini, the Boston-based founder and managing principal with Domini Social Investments LLC, New York. Socially responsible investors recognize that some actions done for the greater good have an upfront cost, but also can pay dividends down the line, she adds. Domini says that in an average year most mutual funds turn over all the stocks they hold. As a result, many mutual-fund managers don't care if your company survives to the next year, she asserts. "Socially responsible funds operate within the belly of the beast to introduce some common sense." That is, while they want their holdings to make money (and will sell those that are performing poorly), socially responsible fund managers tend to take a longer-term view, and want the companies they hold to consider all stakeholders. That said, socially responsible investors don't shy away from confrontation. "We are, in fact, owners of the company, and at a certain point owners of the company have a voice," says Domini. Socially responsible investors are becoming more adept at such actions as initiating shareholder resolutions. As their name suggests, these are issues that shareholders in the company vote on. For instance, a resolution may ask management to disclose information on the working environment in its overseas plants. How can corporate management best work with socially responsible investors? Experts offer the following guidelines.

  • "Keep the dialogue going," advises Catherine Hickey, an analyst with Morningstar Inc., the Chicago-based financial information firm. Executives who meet with socially responsible fund managers, just as they would any other large shareholders, typically fare better than those who stonewall. That's particularly true for executives in manufacturing companies, which sometimes are wrongly perceived as having a poor environmental record. "There's a general ignorance on the part of the public about what happens in manufacturing facilities," says Ray Anderson, chief executive officer with Interface Inc., Atlanta, a leading producer of carpet squares. Anderson also is an outspoken advocate for environmentally friendly manufacturing processes.
  • Don't wait until things are perfect. "Socially responsible investors don't expect companies to be run by holy men and women," says Lloyd Kurtz, director of quantitative research with Harris Bretall Sullivan & Smith, a money management firm in San Francisco. Mark Regier, the socially responsible investing research and advocacy coordinator for MMA Financial Services, Goshen, Ind., provides an example. He and managers of similar funds met with Goodyear Tire & Rubber Co., Akron, Ohio, several years ago, and Goodyear's management team brought up an ad campaign that had run in one of the company's foreign divisions. The advertising contained a racial slur. "We were impressed that they were there to tell us that this wasn't their values, and wasn't what they stood for," says Regier. Goodyear also pledged to extend its diversity training across the globe; it previously had been focused within the U.S. Many of the funds there, including MMA, continued to hold the stock, says Regier. (According to its Web site, Goodyear currently is not among MMA's investments.)
  • Keep expectations reasonable. A strong social-responsibility record won't automatically translate to a great stock price. Interface, for instance, has made strides in employing truly sustainable manufacturing processes. The company produces a carpet made entirely from recycled materials and has converted to energy-efficient manufacturing processes. As a result, Interface has slashed $140 million from its expenses over the last five years just by eliminating waste. Still, as of mid-November, Interface shares were trading at a lackluster $9. However, Anderson says the impact of the company's environmental leadership extends beyond the stock market. "People really do want to be associated with a higher purpose, and have a transcendent aspect to what they do," he says. "The environmental commitment we've made provides that higher purpose."
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