has been outpacing almost all its competitors lately. The fund returned 13.1% annually during the five years ending in September, more than 8 percentage points ahead of the S&P 500, according to Morningstar.
Portfolio manager Nick Kaiser accomplished that feat by avoiding financial stocks, which have been among the biggest losers this year. Does Kaiser deserve praise for brilliant foresight? Not necessarily. Designed to serve Muslims, Amana never buys financial stocks because Islamic law forbids the lending of money bearing interest.
Amana's showing underlines the success of socially responsible funds, which invest according to a variety of ethical guidelines. Some social portfolios steer clear of gambling stocks, others invest only in so-called green companies. During the past decade, domestic equity funds that invest according to social criteria have returned 4.7% annually, more than a percentage point better than the S&P 500. In the downturn of the past year, social funds lost 2 percentage points less than the benchmark.
The success of the funds should come as a surprise to academics who have long sneered at social funds, claiming the do-gooders are bound to underperform. They argue that social funds violate a cardinal rule of investing: It pays to diversify. Portfolios with broad diversification tend to outdo narrow collections of stocks. By this thinking, social funds should suffer from a handicap because they screen out some stocks.
But recent research shows that social investing can produce competitive returns. Good managers can excel, even if they must avoid dozens of stocks. "There is no evidence that fund returns are penalized when managers use social screens," says David Kathman, a mutual fund analyst at Morningstar.
A decade ago, only a few social funds existed. Typical offerings aimed to avoid companies that produced tobacco, alcohol and weapons. Some funds sought to shun businesses that polluted or violated labor rules. Lately more specialized funds have appeared, including portfolios for Catholics and supporters of alternative energy. Now Morningstar tracks 118 socially responsible funds.
While the funds follow different strategies, some trends have appeared. In general, the funds emphasize growth stocks, including technology and health shares. This is because those companies tend not to pollute. At the same time, many funds are underweight energy and industrial companies, which may violate environmental rules. Because of the weightings, social funds excel in some years and lag in others. Social funds beat their benchmarks in the late 1990s, a time when technology stocks led the markets. When value stocks climbed in 2006, social funds trailed. This year, social funds have enjoyed an advantage because they underweight energy and industrial stocks, which have sunk in recent months.
Seeing the recent performance, some investors may conclude that social funds will continue being long-run winners. That is impossible to predict. But you should feel free to buy a sound fund that supports your favorite cause.
Investors seeking a tame choice might consider
Pax World Balanced
, which holds a mix of high-grade bonds and blue-chip stocks. During the past five years, the fund has returned 5.3% annually, compared to 5.1% for the S&P 500. Started in 1971, the fund has long avoided alcohol and tobacco. More recently, Pax has begun emphasizing companies with strong records for dealing with employees and the environment. Stocks in the portfolio include solid blue chips with growing earnings, such as Deere and Procter & Gamble.
Another fund that seeks growing blue chips is
Neuberger Berman Socially Responsive
, which returned 7.4% annually during the past five years. The portfolio managers look for solid companies that are temporarily cheap because of minor problems.
While some social funds avoid companies involved in fossil fuels, Neuberger Berman Socially Responsive aims to buy the best choices available, including energy businesses with relatively strong environmental records, such as BP, which supports alternative energy projects.
Critics of the social screens used by Neuberger and other companies complain that the criteria used for stock selection can be unclear. Who is to say that one company is better for the environment than another? Social portfolio managers counter that all investing requires making subjective judgments. The managers say that by rigorously poring through data, it is possible to pick companies that are sound investments and solid corporate citizens.
Whether the screens seem fair, the returns of social funds appear solid. Investors can support their favorite causes without necessarily sacrificing their wallets.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.