The Feel-Good Funds

By Barbara Kiviat

Investors seeking to make money with a clean conscience are flocking to socially responsible mutual funds, which invest in companies that meet nonfinancial standards like environmental friendliness and respect for workers' rights. Assets in such funds have jumped 156% over the past five years, to $31.9 billion, while the fund industry as a whole has grown just 22%, according to fund tracker Lipper. But a recent study by environmentalist Paul Hawken suggests investors might be getting more than they bargained for. Hawken, who runs the Natural Capital Institute in San Francisco, found socially responsible funds owning companies like Iraq-entangled Halliburton, tobacco-products maker Altria and weapons manufacturer Raytheon.

What's going on here? Many self-described socially responsible funds tailor their investment criteria narrowly, screening companies solely on the basis of, say, promotion of unionized labor or links to abortion. Other funds just knock the worst offenders out of contention and still buy companies that violate stated principles--as long as other companies in the same industry do worse. But even socially responsible funds that weed out a broader swath of companies and corporate practices may wind up not meshing with investors' convictions when it comes down to the gritty details.

"Everyone has their own standards," says Greg Carlson, an analyst at investment tracker Morningstar. "There's no clear line between what's socially responsible and what's not." That's how two respected socially responsible benchmarks--Calvert Social Index and Domini 400 Social Index--wind up holding different groups of companies. While Calvert doesn't hold McDonald's because it fails the index's labor-practices screen, Domini does. And though Domini rejects Pfizer partly on the basis of its environmental record and product-safety issues, Calvert includes the drug giant. "You have a lot of companies where reasonable people can disagree," says Adam Kanzer, director of shareholder advocacy at Domini. His advice for investors: "Know what you're buying." A good starting place is the fine print found in a fund prospectus.

And don't be blinded by the notion of benevolence. You're buying a mutual fund, not volunteering at a soup kitchen. Making money is part of the point. As with any sort of fund, you should look for low expenses, experienced management and a good track record. Calvert Social Investment Equity, a large-cap growth-plus-value fund that screens companies in seven areas, has fared better than the vast majority of large-cap blended funds over the past five years (although it has fallen behind the pack recently). Ariel Fund, a small-cap value fund, isn't nearly so stringent about screening but does exclude companies that focus on making or selling tobacco, generating nuclear energy or manufacturing handguns. The ultracheap Vanguard Calvert Social Index makes a decent core holding, Parnassus Equity Income looks for stand-up corporate citizens while buying stocks that pay high dividends, and Pax World Balanced gives investors exposure to bonds as well as stocks. So go ahead, make a little money--and feel good while you do it.