Reality Check

September 01, 2006

Matt HouganAnn Domini, the co-creator of the world's first socially responsible investing index, the Domini 400, has gone over to the dark side.

No, she hasn't started investing all her money in Phillip Morris and ExxonMobil. And no, she hasn't switched her assets to the International Securities Exchange's SINDEX, with its toxic combination of alcohol and tobacco- related names, either.

It is worse than all that... far worse: She's abandoning indexing in favor of active management.

Domini launched the Domini 400 Index and a related index fund in 1990 to prove that it was possible to have a conscience AND m a ke money in the stock market at the same time. Remarkably, it worked: Since inception, the Domini 400 has beaten the S&P 500, delivering annualized returns of 12.03 percent vs. 11.31 percent for the erstwhile 500. In other words, you can have your organic, homemade, GMO-free cake... and eat it too.

Thanks largely to the success of the index, money has flooded into the formerly tiny field of socially responsible investing (SRI). According to the Social Investment Forum, there are $2.29 trillion invested in a socially responsible manner in the U.S. The Domini 400 Index Fund has a healthy $1.2 billion of that.

Recently, however, Domini asked her shareholders to take a leap of faith ... off the cliff of active investing. Seduced by the siren song of active management, Domini filed a proxy looking to drop the fund's boring old index philosophy and ride the sweet gravy train of momentum-based trading to better returns. The social screens will stay in place, but Wellington Asset Management will use a fancy, computer-driven analysis to choose hot stocks.

Oh yeah, I almost forgot: The expense ratio is going up, too. Domini will boost the expense ratio on the fund from an alre a d y high 95 basis points to a downright startling 1.15 percent. The 20 basis point jump works out to an additional $2.4 million per year in cold, hard cash. To keep the green coming in, the group is introducing loaded shares as well. Could a hedge fund be next? Two and 20 sounds mighty attractive. (I can see the hybrid convertibles and luxury eco- villas twinkling in the eyes of the worker bees at Domini headquarters.)

As a student of indexing, Ann Domini must know that this approach is doomed. In fact, I know that she knows that it is doomed. Just look at the Domini Funds Web site: "While some actively managed funds have e xcellent long-term records, index funds, on average, tend to have better long-term returns than actively managed funds with similar objectives."

Good advice, I'd say.

"I can see the hybrid convertibles and luxury eco-villas twinkling in the eyes of the worker bees at Domini headquarters."

The funny thing is, it's not just Domini that's mucking up their SRI investment policy. Another socially responsible fund company, Pax World Funds, recently announced plans to loosen its "zero tolerance" policy for alcohol and gambling stocks. I know that Vegas is the hot new family vacation destination, but seriously: What does this all mean?

The truth is that these old-line socially responsible investing firms are falling victim to their own success. Having proved that social investing can work, they've attracted the behemoths to the field-companies like Vanguard and Barclays Global Investors have recently launched socially screened funds, using their heft to drive down expense ratios and grow assets. At the same time, a rebound in smokestack industries has made it hard for social funds to put up impressive performance numbers. And it's all about performance. These indexes rode the tech boom; now they're trying have it both ways and actively dance their way around underperformance.

But going active-or embracing gambling-well, that just seems desperate. Instead, take a page from the true index investor's playbook. If you're looking for better returns, don't embrace the dark side of active management. Try lowering your fees instead.

Find your next ETF

Reset All