Socially responsible investing and indexed investing are two trends that have developed fairly wide followings in recent years. It's not surprising then that some fund management companies have combined the two methods. What may be a tad surprising though, is the fact that these hybrid funds have performed so well.
Domini Social Investments, a subsidiary of Kinder, Lydenberg, Domini & Co., Inc., offers the Domini Social Equity Fund. The fund is based on the Domini 400 Social Index which was launched in 1990. The fund has been available to investors since 1991.
In 1990 the S&P500 was subjected to a variety of social screens. Roughly 250 companies were left after the elimination process. Then another 100 screened companies from outside the index were selected to regain some of the diversification that was lost in the original screening process, bringing the total to 350 companies.
"The last 50 companies that were added were companies with particularly strong social stories. Not necessarily because of diversification but because they had a strong social message or were really at the leading edge in their area or doing something really admirable," David Wieder, a Domini spokesperson said.
The fund outperformed the S&P500 by 0.08% per year over the 1992-1998 period.
Wieder attributes the index's ability to keep pace with the S&P 500 to a few factors, including the Domini 400's heavier weighting in technology.
"Generally, what we like to think and what the data show is that, really, our performance is due to specific stock selection. And, the only significant stock selection we do is according to social criteria. We like to think that a company that's more progressive about the needs of their community, about their employees, about the environment, generally has a visionary management. We think it has a difference in terms of the quality of the management in general," he said.
Domini screens the component companies for a variety of issues, including a company's positive or negative impact on its local communities, its promotion of diversity within the workplace, its employee relations record, its environmental record and policies, its conduct regarding its overseas operations, the quality and social value of its products and how much it pays its top management or board directors. Strong performances in these areas can aid a company's chances for inclusion in the index, while poor performances may result in exclusion. Companies with interests in alcohol, tobacco, gambling, the military and nuclear power are automatically excluded.
When a company needs to be replaced, the replacement company's social record, its industry group, its inclusion or exclusion from the S&P 500 and how it compares with the company that is being removed are all considered before a decision is made. Generally, companies are removed because of mergers and acquisitions, according to Wieder. Only one or two companies each year are removed because they have violated the screening standards of the index.
The fund's top ten holdings as of June 30 included Coca-Cola, Wal-Mart, Cisco Systems and Merck. Microsoft was the largest holding at 7.64%.
Citizens Funds, a mutual fund company specializing in socially and environmentally responsible investing, operates the Citizens Index Fund based on its own proprietary index. The fund has been available to individual and institutional investors since January 1996.
Like the Domini 400 Social Index, the Citizens Index was arrived at by screening the S&P 500. Roughly 200 companies made it through the original screening process and were supplemented by the addition of another 100 approved companies from outside the S&P 500 chosen to round out the sector and industry weightings. "The index's sector classification system is similar to the S&P 500's but certain sectors and industries have been completely eliminated. Some sectors we avoid completely, such as tobacco, aerospace, and oil. We're more heavily weighted in areas like technology, telecommunications, financial services and consumer services," a spokesperson for Citizens Funds said.
Over half of the fund's top ten holdings were technology companies as of April 30, 1999. Nine out of the ten were involved in communications or technology. The remaining company was Coca-Cola Co.
The market capitalization-weighted Citizens Index has screens set up to block companies with unsatisfactory records in environmental issues, equal opportunity, employee and community relations, human rights and the treatment of animals. Like Domini, it also excludes companies that produce alcohol or tobacco products and companies that have significant interests in nuclear power, weapons or gambling.
This screening process eliminates a fairly large number of companies from eligibility for inclusion in the index. Yet it doesn't seem to hurt the index or the fund's returns. Since 1995, the index has consistently outperformed the S&P 500, and, in 1998, it beat the S&P 500 by over 16%.
"We think it's because our social screen has us invested in the companies and industries that are really leading and emerging in the economy," the Citizens Funds' spokesperson said of the Citizens Index's superior performance. He described the U.S. economy as increasingly based on technology and information services. "These are the industries that are driving the economy. The industries we exclude are industries that have not been performing well."
Sales for the Citizens Index Fund were up 240% for 1998.
However, there will soon be some new kids on the block. Walden Asset Management, a division of United States Trust Co. of Boston, expects to release two socially responsible index funds before year end.
The Walden/BBT Domestic Social Index Fund uses the S&P 500 as its universe of stocks and seeks to parallel the index's performance. Unlike the Domini and Citizens Funds, Walden will not maintain its own separate index; the fund's holdings are limited to stocks within the S&P500 that meet its standards.
"Only about 30 companies were removed," Lauren Compere, a spokesperson for Walden, said.
The fund seeks to actively promote the values it supports through the use of shareholder advocacy. It also excludes companies involved in tobacco, alcohol, gaming activities and weapons. Despite the screens, its sector allocations are otherwise extremely similar to those in the S&P500.
The Walden/BBTInternational Social Index Fund may very well be the first socially responsible international index fund. Its objective is to parallel the Morgan Stanley Capital International Europe Australia Far East Index. While Walden's domestic fund is restricted to companies in the S&P 500, its international fund is permitted to invest in stocks outside the MSCI EAFE in order to fill gaps in sector allocation caused by the omission of companies.
The fund will attempt to invest in companies with superior environmental and employee relations records and socially beneficial products. Like the other Walden fund, it avoids tobacco, alcohol, gaming activities and weapons.
Since others have tinkered successfully with the S&P 500, it is not surprising that Standard & Poor's was recently in talks with Vanguard Group to discuss the feasibility of constructing a socially responsible index, according to a number of news sources. Dow Jones recently released a Shariah-compliant global index of stocks, the Dow Jones Islamic Market Index, that in practice also adopts many "socially responsible" practices, and as we went to press announced a new Sustainability Index, with 229 companies worldwide committed to the environment, innovative technology, and social well-being, designed so investors can also screen out alcohol, gaming and tobacco stocks as they choose.
William Jordan, spokesperson for S&P, was quick to downplay the initial excitement the S&P announcement caused. "We are not currently planning to do a socially screened index."
S&P has been approached by a number of fund families and institutional investors in recent years about constructing a socially screened index, he said. "We have considered it; we are considering it, but we have no plans to move forward right now on a short-term basis."
"The question becomes who chooses the stocks and what criteria do you use?"
Jordan elaborated. "One person's social conscience might not be another person's social conscience" Jordan pointed out that while tobacco and alcohol are widely agreed to be taboo industries, other issues, such as the environment, abortion and the defense industry tend to produce a wide range of reactions in different individuals.
"How do you effectively design an index and an index fund to accommodate those diverse needs? I'm not saying it cannot be done, but from an index perspective it's problematic."
Individual socially responsible index funds may construct an index to suit their stated criteria and investment goals, but an index provider has the additional responsibility of accurately representing the market, Jordan pointed out. S