Social Investing: Big Business, Big Challenges

More and more individuals and organizations pay increasingly close attention these days to where their money is invested. According to figures gathered by the Social Investment Forum, a nonprofit organization based in Washington, D.C., total assets under management in socially screened portfolios have risen from $529 billion to more than $1.5 trillion in just the past three years. Socially responsible funds are growing at twice the rate of other mutual funds. In 1995 55 funds were labeled socially responsible. By the end of last year, that number had risen to 175. Social investing is clearly big business.

Earlier this month, Wharton’s Zicklin Center for Business Ethics Research sponsored a one-day conference on the social screening of investments, a relatively recent phenomenon whose growing popularity brings with it both new opportunities and new challenges.

To begin with, the term “socially responsible investments” needs clarification. Not long ago, the term meant simply avoiding investments in companies that were doing business in South Africa. Before long, a small number of investment managers began to exclude investments in firms associated with tobacco, alcohol, or firearms. The definition has become even broader in recent years. One has only to do a quick search on the Internet to find investment managers who offer funds that will satisfy virtually any philosophy.

Socially responsible investing has historically been based on negative screening – i.e. ruling out investments in certain types of businesses. All of the Zicklin Center participants spoke of the difficulty in setting up appropriate screens for companies they analyze. To no small degree, the definition of socially responsible investing changes from person to person. Some individuals focus on the products the company makes, others focus on how employees are treated, still others focus on additional intangibles such as a company’s impact on the environment.

This is not a field that lends itself to precise metrics. Historically, points out Wharton professor Alan Strudler, socially responsible funds used alcohol, tobacco, gambling, military products, and nuclear power as their screens to eliminate companies. General Electric, one of the world’s most successful companies, would have been eliminated because it has an extremely small division that makes products for the nuclear power industry. A far larger part of GE’s business is its medical products division that produces such life-saving products as MRIs and CAT scanning machines. “Is GE any less moral than, for example, Microsoft, which has been found to have engaged in monopolistic behavior?” asks Strudler. “Is it more moral to encourage the production and consumption of Coca Cola?”

The pendulum is now swinging from negative to positive screening. Investment managers are beginning to look at a far broader range of corporate behavior and then make investment decisions based on how responsible a company is as part of the global community. This approach, however, brings with it two major challenges. The first is avoiding what Thomas Grant, president of the Pax World Fund, calls “cultural imperialism”. Americans, he observes, tend to put their stamp on what is “right”, “moral”, “ethical”, and “socially responsible”. It begs the question as to whether American-based fund managers can apply an American definition of “socially responsible” to operations of companies in other parts of the world, especially third-world countries.

The other major challenge is that involved with gathering and analyzing information. It is difficult enough to predict a company’s earnings for the next quarter. It is that much more difficult to measure a company’s success against a specified list of characteristics that a given fund manager has defined as socially responsible. One group that is working to address this particular challenge is the Global Reporting Initiative. Mike Peirce, of the Institute of Social and Ethical Accountability, says that the GRI’s goal is to work toward a global standardization of reporting as well as performance measurement.

But even as investment managers attempt to achieve certain philosophical objectives with their investments and their strategies, all agreed that performance matters. Investors may believe in the cause, but there was consensus that investors would not sacrifice performance for good works. As it turns out, over the past few years socially responsive funds have been able to combine their philosophical goals with superior performance. According to Steven Schueth, president of the Social Investment Forum, the majority of socially responsive funds with assets of $100 million or more earned top ratings from Morningstar, Lipper or both. Schueth’s organization recently completed an analysis showing that “socially responsible funds are about twice as likely as all mutual funds to earn the respected Morningstar top five-star rating”. All agreed that should even the most compelling fund falter in its investment performance, investors would be likely to move their money elsewhere.

Socially responsible investing is still in its adolescent stage. But its potential impact is enormous. The very nature of the business is changing. No longer will the most successful funds be those that have negative screens, i.e. that assert they do not invest in certain businesses. Rather, the growth promises to be in those funds that develop new ways to do positive screening, weighing companies not on what business they are in, but more broadly, on how they conduct their business.

Analysts will push harder for information that goes well beyond what is on a company’s revenue statement or balance sheet.. Senior management in every industry will find themselves asked questions that may begin with how much inventory remains unsold in a warehouse, but end with how much community investing the company does, or what the company is doing to improve working conditions for employees in facilities in developing countries. The current size of the socially responsible investment industry – and its prospects for continued rapid growth – promise to make social investing a powerful force in the global economy.

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