Social Investing Gathers Momentum

(This story has been corrected to show in the 13th paragraph that the Social Choice Account has a 60/40 equity/fixed income split and exposure to international stocks instead of the Social Choice Equity Fund in the 14th paragraph. The former 14th and 15th paragraphs have been combined.)

Despite evidence that nearly two-thirds of 160 socially responsible mutual funds offered by member companies of the Social Investment Forum outperformed their benchmark indexes and beat the Standard & Poor's 500-stock index in 2009 by significant margins, most institutional investors remain convinced that socially responsible investing (SRI) means giving up some return on investment.

The funds' solid track record—and some recent actions by U.S. securities regulators—may give a fresh boost to the SRI approach.

On Jan. 27 the U.S. Securities & Exchange Commission approved a standard that requires public companies to weigh the impact of climate-change laws and regulations when deciding which information to disclose in corporate filings. The SEC said companies should also consider international accords, indirect effects such as reduced demand for goods tied to greenhouse gas production, and physical impacts such as the potential for increased insurance claims in coastal regions due to rising sea levels in their assessments.

Meg Voorhes, research director of general programs at the Washington-based Social Investment Forum, which counts 22 fund outfits among its members, expects the standard to give investors a better basis for comparison for companies' environmental risks, and may also provide a better way to assess management and to engage with them about the risks they're taking, she says.

The results of a December 2009 survey of 40 investment consulting firms showed that nearly 90% of the firms believe client interest in SRI would increase over the next three years, driven in part by climate-change regulation and retail customers' growing interest in green investing.

Institutional Investors See "Trade-Off"

While SRI has been gaining in popularity among retail investors, institutions such as pension funds generally have much longer investment time horizons that cause them to focus on different risk-adjusted returns, says Matt Moscardi, manager of investor programs at Ceres, an advocacy group that works with companies to address sustainability challenges.

"A lot of SRIs don't meet some of [the institutions'] criteria," he says. "At a $100 billion-plus fund, it's harder for them to get interested in an SRI fund because there's still a perceived trade-off between returns and doing the responsible thing."

Bozena Jankowska, manager of the Allianz RCM Global Ecotrends Fund (AECOX), thinks it's important that institutional investors first be clear on the distinctions between ethical, or faith-based, funds; SRI funds; and funds based on a theme such as clean energy. Faith-based funds, by excluding companies tied to abortion and contraception, and SRI, by screening for objectionable environmental, social, and governance (ESG) practices, tend to restrict the pool of investable companies, she says.

"Sustainability investing provides a much broader universe because its approach is best-in-class stocks," she says. "It's a far more pragmatic approach that focuses on …how [companies] are adapting their business strategies to social and environmental changes to give them ongoing license to operate and get market leadership ahead of the competition."

Public Pension Plans Offer SRI Options

Public pension plan managers, after taking significant losses in the 1980s and early 1990s on investments designed to save jobs or promote homeownership, now "go out of their way to make clear that they are no longer willing to sacrifice returns for social considerations," according to an August 2007 report by the Center for Retirement Research at Boston College. A requirement that an investment yield a "market rate of return" is a feature of nearly every definition of social investing, the report said.

Socially responsible investing isn't available to private-sector defined benefit plans, whose fiduciaries are prohibited from subordinating the financial interests of plan participants and beneficiaries to other considerations by the Employee Retirement Income Security Act (ERISA).

The California State Teachers Retirement System (CalSTRS), the California State Public Employees Retirement System (CalPERS), and the New York City Employees Retirement System (NYCERS) have been offering options by which their constituents can invest in environmental and other SRI-oriented stocks for many years.

TIAA-CREF, which constructs retirement plans for 3.6 million people in the academic, medical, cultural, and research fields, has been offering ESG-screened investing options for the past 20 years. Roughly 500,000 of its members devote some of their allocation to the Social Choice Account, a retirement annuity with $8 billion in assets as of Sept. 30, 2009 and a 60/40 equity/fixed income split. Two years ago, the annuity added exposure to international stocks. Participation in the annuity tends to skew more toward younger and women investors, says Amy O'Brien, a director in TIAA-CREF's global, social, and community investing department, which is part of the asset management division.

Spreading Beyond Retirement Programs

The company also offers the Social Choice Equity Fund, a mutual fund with about $700 million in assets as of Sept. 30. The fund is available to people who don't participate in TIAA-CREF's retirement plans. Lately, O'Brien has been seeing wider use of SRI options outside of retirement platforms. Connecticut's college savings program began to offer TIAA-CREF's Social Choice fund in its 529 plans in November 2007. And endowment programs are finding new ways to leverage interest among donors and alumni. The University of Utah added the Social Choice fund as an option for high-net-worth donors about two years ago.

"Our emphasis is more on corporate action and shareholder advocacy because we're universal owners and over the long term we think these factors will contribute to the core goal, which is retirement security to investors," says O'Brien.

Private Equity Path

The real interest among institutional investors in environmental bets has been on the venture capital and private equity side, although certain states' public retirement funds, such as Vermont's, aren't allowed to invest in them, says Moscardi at Ceres.

Unlike TIAA-CREF, CalPERS doesn't manage individual retirement accounts for its 1.6 million members, so members aren't able to choose how much exposure they want to environmentally responsible companies. CalPERS has been investing in environmental assets since 2004 and most of the more than $1 billion it currently has committed to this category is in its private equity program, focused mostly on alternative energy and other clean technology startups, says Clark McKinley, a spokesman for the retirement system.

The external portfolio managers that CalPERS employs to oversee its global equity program build index funds using environmental screens and taking into account other SRI factors such as human-rights practices to pick stocks.

CalPERS' mandate is to maximize investment returns to keep the state's retirement system funded. "That's why we're in private equity in the first place. Private equity is a good portfolio diversifier," says McKinley. "We look for private equity to beat the stock market by at least three percentage points annually."

The fact that many green energy funds have higher volatility than most small-cap growth funds may make them unsuitable for conservative institutional investors, and argues for smaller allocations by retail investors, says Bill Rocco, an analyst at Morningstar Funds (MORN). Last year, in the wake of the financial crisis, most solar and wind stocks took a huge hit, and some pros say they tend to perform better during periods of economic strength, as some investors seem to be drawn to them as a hedge against rising oil prices and inflation.

The sell-off in green energy stocks in early 2009 had less to do with economic fundamentals than with the banks putting a halt to lending, which hurts small companies more than larger ones, says Moscardi. Since solar and wind projects require bigger capital outlays up front, investors sold the shares despite the U.S. government's plan to pump tens of billions of dollars into energy efficiency projects, he says. With the economy starting to recover, cleantech indexes gained more than 8% in January as the market began to focus on the opportunities again, he adds.

Some Experts Still Resist

Moscardi sees a prolonged, uphill effort to convince most institutional asset managers of the financial merits of sustainable investing. Even the New York City Employees Retirement System, considered a very progressive asset manager, has less than 1% of its assets dedicated to sustainable investing options.

Some retirement benefits experts like Alicia Munnell at the Center for Retirement Research at Boston College balk at the idea of encouraging managers of public pension funds to start picking investments based on social considerations. "It requires an investment of time, and it's very hard to tell an environmentally good company from an environmentally bad company," she says. "CalPERS' managers are extremely sophisticated," but many public pension fund managers across the U.S. aren't, and their investment decisions are subject to political posturing in back rooms.

To allow pension managers to "take their eyes off the prize of maximum returns" can only hurt future beneficiaries and taxpayers, she says.

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