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Matching Money and Morals

Debating socially responsible investing is a bit like arguing whether a glass is half full or half empty. Research has shown that returns from socially responsible investing, or SRI, can be roughly equal to those of index funds. But critics argue that matching index-fund returns isn't good enough, especially given that expenses are often higher for socially responsible funds.

Despite the passionate debate, more investors are opting to marry their money with their morals. Total SRI assets rose more than 258%, to $2.29 trillion, in 2005, surpassing the 249% increase for all assets under management, according to the Social Investment Forum, a nonprofit trade association for the SRI industry.

Investors are choosing funds that exclude "sin stocks" such as Altria (MO - Get Report), Anheuser-Busch (BUD) and Harrah's Entertainment (HET). Sometimes SRI practitioners go even further by screening companies on the basis of religious beliefs, labor practices and environmental records.

Many investors, however, still are not sure how SRI returns compare with those of other mutual funds, according to a recent survey for Calvert, one of the largest SRI fund companies.

And there's the rub: Critics say investing on the basis of morals runs counter to efficient market theory. Indeed, TheStreet.com's own Jim Cramer has argued that investors are better off making as much money as they can (legally) and then donating their proceeds to charity.

But other experts disagree. "That's like telling an Orthodox Jew to buy cheaper nonkosher meat and donate the savings to the synagogue," quips Santa Clara University finance professor Meir Statman, who has studied SRI since the early 1990s.

In a 2000 study, Statman found that the difference in risk-adjusted returns of the Domini Social Index, an index of 400 socially responsible stocks, and the S&P 500 was not statistically significant between 1990 and 1998.

Statman also compared the returns of 31 socially conscious and 62 conventional mutual funds of roughly equal asset size and expense ratio. He found that the returns of all socially responsible funds trailed those of the Domini Social Index and S&P 500 but outperformed those of the conventional funds, although the difference was not statistically significant.

Statman updated his research of the indices last year, extending the period of analysis through April 2004 and adding the (CSXAX) Calvert Social Index , the Citizens Index and the U.S. portion of the Dow Jones Sustainability Index. The SRI funds still did better.

The problem is that their expenses are higher than those encountered when investing in a standard index, Statman acknowledges.

"You might say in statistical terms that the advantage given by the Domini Index is being eaten away, at least for individual investors, by the higher expense ratio," Statman says.

SRI Indices v. Vanguard 500 Index
RETURNS ANNUALIZED
Fund Expense Ratio % 1-YEAR 3-YEAR 5-YEAR 10-YEAR
Vanguard 500 Index 0.18 11.75 15.97 3.35 8.88
Domini Social Equity (based on Domini 400 Social Index) 0.95 10.79 13.77 2.51 8.32
Calvert Social Index 0.75 12.75 14.24 1.94 N/A
Citizens 300 (based on Citizens Index) 0.9 10.01 N/A N/A N/A
Source: Morningstar

Meanwhile, professors at Wharton found that investors who prefer actively managed mutual funds over indices fare worse if they narrow their choices with SRI screens. Professors Robert Stambaugh and Christopher Geczy and grad student David Levin found that investors who choose actively managed SRI funds can lose more than 3.5 percentage points of return a year as their investment strategies get narrower -- limiting investments to value stocks or small-company stocks, for instance.

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