Rating the SRI Funds
Investors face a persistent challenge in understanding the varied criteria used by socially responsible mutual funds to select portfolio holdings. As there are no universal standards for the industry, a fund that excludes only tobacco from consideration, or that has a specific religious or other focus, is grouped in the socially responsible investment (SRI) category with dozens of other funds which apply a broader range of ethical criteria to the selection of companies. Like the concept of sustainability, social responsibility can address a combination of variables, such as avoidance and affirmative screens, shareholder advocacy, and community development investing. Fund companies may address industries, corporate practices across sectors, and numerous international issues, by conducting social research using internal and external resources in unique ways.
Subscribe to Green Money To address this diverse continuum, Natural Investment Services LLC (NIS) in 1992 developed the nation's only social rating system of mutual funds based on objective, standardized criteria, called the NIS Social Rating(SM) [the Rating]. The presentation of the Rating, from 'One Heart' to 'Five Hearts,' is similar to the star-rating used by Morningstar in that it provides a quick and convenient overview of the breadth and depth of social responsibility criteria applied by each fund. Investors can use this snapshot rating as part of their research process in selecting potential SRI mutual funds as investments because it can quickly distinguish funds that are comprehensive in addressing social, environmental, and governance issues.
This year Citizens Advisers, Inc. (manager of Citizens Funds) became the first mutual fund company to license the Rating for use in promotional materials.
The NIS Social Rating is published within the mutual fund performance chart of every issue of GreenMoney Journal and in the annual LOHAS Journal, and can also be found on the Natural Investment Services website at- http://www.naturalinvesting.com
THE NIS HISTORY
Jack Brill developed the Rating while writing Investing from the Heart: The Guide to Socially Responsible Investments and Money Management (Crown, 1992), the first comprehensive SRI book written when there were only 22 SRI funds available. Jack looked at the screens stated in the fund's prospectus and verified with the fund managers how they actually applied the screens, either informally or via written policy. Mutual funds were scored and then awarded a One Heart to Five Heart rating, with 'One' designating a fund with minimum screening and 'Five' given for a fund that was comprehensively screened on many social issues.
Then in 1999, after the 7-year New York Times contest that pitted Jack against four conventional advisors (he placed third and within .5 percent per year of the top performer), Jack and his son Hal, who became an advisor in 1989, wrote Investing with Your Values: Making Money and Making a Difference (Bloomberg Press, 1999) with Cliff Feigenbaum, Publisher of GreenMoney Journal. The SRI mutual fund industry had by then grown from 12 funds in 1990 to 55 mutual funds that defined social criteria in their prospectus, plus over 100 others that qualified due to their selection of particular stocks and bonds. As a result, NIS refined the Rating system and added new credit to funds that participate in Community Investing and Shareholder Activism.
In 2006, a comprehensive evaluation of the Rating resulted in a complete reshaping of the criteria to reflect societal and industry changes in the past seven years.
A NEW METHODOLOGY
Each fund is reviewed annually through a formal questionnaire and an interview with its social research professionals. It is not uncommon for funds to rate differently from year to year, given changes in their social responsibility policies. The methodology used to compile the Rating first addresses the main strategies of corporate SRI: Avoidance and Affirmative Screening.
Avoidance and Affirmative Screening
The NIS Social Rating monitors eight categories of social screens; we do not discern between funds that select companies based on a total avoidance screen and those that include companies deriving a minor percentage of their revenues from some screened industries or practices.
The classic "sin" industries form one category that includes alcohol, firearms, gambling and tobacco. These are the most popular ethical screens in the industry, likely because these are industries most investors have no trouble avoiding and managers can easily eliminate them.
Other industries for which funds are evaluated include military contractors and nuclear power.
The remaining avoidance screen categories address company practices, and include:
* environmental criteria, such as EPA violations, major contributors to global warming (most fossil fuels), and toxic releases and spills;
* unnecessary animal testing;
* employment issues such as violations of the Equal Employment Opportunity Act and International Labor Organization standards, including working conditions and child labor;
* product safety, including unsafe or hazardous products, deceptive marketing and consumer fraud, and offensive images in labeling and marketing;
* human rights issues such as operations in repressive countries and relocation to avoid U.S. laws; and
* corporate governance issues, such as board independence and diversity, company disclosure, including political contributions, accounting independence, options expensing policy, regulatory violations or other forms of bribery, fraud, or corruption, and excessive CEO or executive compensation.
NIS has always maintained that Avoidance Screening, while important, should not be valued the same as Affirmative Screening. Avoidance of companies in certain industries or which maintain specific unethical practices does not provide any leverage to change them. Mutual funds that seek and support alternative energy or invest in companies with progressive employment policies, however, receive special recognition for investing in companies that embrace responsible behaviors. As this effort contributes to the changes valued by socially responsible investors, NIS weights particular Affirmative Screening practices more heavily in its Rating.
We evaluate mutual funds on their level of commitment to the following
* environmental issues, such as pollution prevention systems, environmentally friendly products, renewable energy, sustainability reporting, and cleaner public transportation;
* healthy lifestyle products such as organics, natural fibers, and holistic medicine and wellness;
* employment practices such as workplace diversity (gender, culture, and sexual preference), organized labor relations, employee health and safety, and family benefits policies;
* products and services, which enhance a sustainable quality of life;
* human rights, such as community relations, codes of conduct to address abuses and injustices, signing the CERES principles, and the impact of company activity on the lands and rights of and benefits to indigenous peoples worldwide; and
* responsiveness to shareholder concerns.
The combination of Avoidance and Affirmative Screening criteria represents nearly 60 percent of the total NIS Social Rating.
The power of owning shares of a company comes when shareholders use direct action to bringing about changes in corporate behavior and policy with regards to the environment, employment practices and corporate governance. When compiling the NIS Social Rating we evaluate each fund's dialoguing with companies, drafting and supporting shareholder resolutions, and publishing a proxy voting guide and results. The shareholder activism score represents nearly 18 percent of the total NIS Social Rating, which is more than double its percentage in the previous edition.
The Social Investment Forum has for many years advocated a "1% For Community" campaign in which funds and advisors strive to allocate at least one percent of a portfolio's assets to certified community development financial institutions (CDFIs). As such, performance in this arena is included in the Rating. For equity funds, this criteria may reflect only the nature of the cash position, as there are several categories of social investment options available, and extra weighting is given to funds that dedicate a portion of their total assets to high impact CDFI's such as:
* community banks, credit unions, loan funds; and
* pooled products, including international microfinance programs.
Points are awarded to a lesser degree if funds invest in:
* pooled CRA products, municipal bonds or projects in low-income communities,
* federal agency securities or municipal bonds in moderate-income communities;
* agency bonds and Sallie Mae and SBA loans;
* conventional loans, collateralized mortgage obligations, and corporate bonds.
The community investing score represents nearly 18 percent of the total NIS Social Rating, more than double the previous version, so it is difficult for a SRI fund to receive 'Five Hearts' without significant community investment.
Social Research Capacity
Over the years we have learned that social research is as much art as it is science. Nevertheless, some mutual funds take this responsibility more seriously than others, as evidenced by their own commitment of resources to social research. As such, we introduce this new Rating category this year to distinguish among funds which use an external research organization's social criteria, which is still scorable, from funds which maintain and implement a written social research policy using dedicated internal resources to analyze their own social, environmental, and governance performance. The size of the social research staff and the depth and frequency of their social impact analysis of company holdings are evaluated by NIS, and this category score represents six percent of the total Rating.
THE FINAL SCORE
The NIS Social Rating includes 55 qualifying practices in 11 social research categories. Each item is scored individually and the composite score is compared with the total possible points. The results fall into performance quintiles, with those in the lowest percentile group (0-20%) awarded "One Heart" and those in the highest percentile group (81-100%) "Five Hearts."
USING THE NIS SOCIAL RATING
The NIS Social Rating can provide a snapshot of a fund's social performance, but investors are urged to consult a fund's website, quarterly reports, and annual reports to review a fund's specific portfolio holdings. The Natural Capital Institute's http://www.responsibleinvesting.org is another helpful resource, as is "The Better World Shopping Guide" by Ellis Jones (New Society, 2006).
It should be noted that there are ethical funds based on very specific criteria (e.g. religious or other specific issues). These funds are not evaluated by NIS because they stand for specific values rather than the holistic and more commonplace criteria of the general SRI field, so it would be unfair to compare them to such broader instruments.
The Rating also does not consider financial performance - a fund could earn 'Five Hearts' from NIS and still have a poor financial track record. Conversely, a fund with a 'One Heart' or 'Two Hearts' rating that screens on a limited number of social issues may be a very desirable investment to build a diversified portfolio, or may be screening on an issue that is especially important to a particular investor. Investors would be wise to discuss these variables with a financial professional to assure that they have a good match for their personal social criteria, risk tolerance, and financial expectations.
Brand New NIS Ratings of Screened Mutual Funds
Appleseed - Fund (APPLX) - 4 Hearts
Ariel - Focus Fund (ARFFX) - 3 Hearts
Calvert - Global Alternative Energy Fund (CGAEX) - 5 Hearts
Calvert - International Opportunities Fund (COICX) - 5 Hearts
Forward - Progressive Real Estate Fund (FFREX) - 1 Heart
Gabelli - SRI Fund (SRIGX) - 2 Hearts
MMA Praxis - Growth Index Fund (MGNDX) - 5 Hearts
MMA Praxis - Small Cap Fund (MMSCX) - 5 Hearts
Article by Michael Kramer, Managing Partner and Director of Social Research for Natural Investment Services LLC ( http://www.naturalinvesting.com ), an investment advisor exclusively managing portfolios of socially responsible investments for individuals and institutions. Contact him by email at- Michael@naturalinvesting.com