Investing with your heart can pay off in your wallet

Charity Evaluation: Choosing the Best Charities Out There

You can have your organic cupcake and eat it too. Until recently, investors figured they had to forfeit healthy returns to invest in socially responsible funds and companies.

That was then. A cornucopia of new research indicates that socially responsible funds perform just as well as the market overall, and occasionally better. A shift in investing philosophy is to thank, along with better measurements.

A Niagara Falls of money is flowing into socially responsible funds, which are generally defined as those that invest in companies whose practices are environmentally sensitive and sustainable; that have progressive human resources practices; and that can prove their supply chain, materials sourcing and operations are humane. At the beginning of 2014, about $6.57 trillion was invested in U.S.-based assets deemed socially responsible, up 76 percent from 2012, according to the Forum for Sustainable and Responsible Investment, a group based in the District of Columbia.

Socially responsible investment funds have burst from the closet, and the largest fund companies are in on the action. Vanguard, for instance, offers the FTSE Social Index Fund (ticker: VFTSX), which Morningstar deems the lowest-cost socially responsible investment fund (it has an expense ratio of 0.27 percent, or $27 for every $10,000 invested).

Chad Graves, managing director of Morgan Stanley Consulting Group in Connecticut, said the bank scrutinized hundreds of studies about socially responsible investments and found the funds do as well, and sometimes better, than the market. "There's nothing in the data that indicates that you are sacrificing returns, and when done properly, there is a slightly better performance," he said at the Morningstar Investment Conference in Chicago in June.

Much of that is due to funds designed not just to avoid vice, but to reward virtue. In the past, managers say, funds have been defined by what they don't include: tobacco, alcohol, firearms, defense suppliers and companies with histories of destructive environmental and social practices – strip mining, oil spills, chemical disasters and unsafe operations.

Now, the managers of socially responsible funds are using that filter to find companies whose current virtuous practices are likely to result in better results tomorrow. That means finding companies, for instance, that are cultivating diverse talent far down their pipelines so they will have leaders reflective of emerging markets.

The approach of restricting and excluding certain types of equities means "when your only step forward is to restrict, you're almost by definition going to not perform as well," says Mary Jane McQuillen, a portfolio manager for Clearbridge Investments, a division of Legg Mason in New York.

Clearbridge concentrates on socially responsible investments. "When you're creating a portfolio that meets your investment screens, and that meets other criteria, and only afterward you take out what you don't want, the results are quite different," she says.

"The thinking in the industry is that at the very least, we want high-performance [socially responsible] products. That has been an important objective. We don't want investors to say, 'Do I go with principles but get subpar performance?' We want both," McQuillen says.

In April, Clearbridge launched a "sustainability leaders' fund" of 35 stocks that are best in class for financial, environmental and social governance.

McQuillen says SRI is now big enough to lead change, not just reflect it. She and other fund managers say they dig deep to validate companies' claims to socially responsible practices, seeking proof at every point in supply chains and operations. They believe their holistic approach is changing how companies think – both companies they've invested in and companies that would like the reputational halo of being known as socially responsible.

"Ideally we're seeking change not just in processes that have impact on society but also challenging performance and operations," McQuillen says. SRI is about more than today's headlines, she says; "it's about understanding the life cycle of the business model, what they do and how they do it."

One example is Trex Co. (TREX), a company that processes recycled plastics and sawdust into deck planking. "It's an environmentally solid process and product, plus it makes a lot of money," McQuillen says. "And it's a good product for consumers."

Another is the Pax Ellevate Global Women's Index Fund (PXWEX), which includes 400 companies that track with Pax Global Women's Leadership Index. Top holdings include Aetna (AET), Microsoft Corp. (MSFT), Lockheed Martin Corp. (LMT) and KeyCorp (KEY).

LGBT is the latest frontier. John Roberts runs the Workplace Equality Portfolio (EQLT), which includes 196 companies that support lesbian, gay, bisexual and transgender equality. Roberts, a longtime financial manager, says the exchange-traded fund has outperformed the Standard & Poor's 500 index by 250 basis points per year for the past decade. The top holdings in the fund are ConAgra Foods (CAG), JetBlue Airways (JBLU), Cigna Corp. (CI), Owens Corning (OC) and Facebook (FB).

"There's a little bit of a small-cap bias, but you cannot identify all of the outperformance by financial factors or by industry sector," he says. "What we think that is going on is that we have found a factor that doesn't show up in financial indices. We've found companies with cultures that treat all their employees with respect, and that drives better results."

Copyright 2015 U.S. News & World Report

Click through the slideshow below to see some of the most charitable states:

Least to Most Charitable States
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Investing with your heart can pay off in your wallet

50. New Hampshire - 1.74%

49T.  Maine - 1.95%

49T. Vermont - 1.95%

47. New Jersey - 2.01%

46. Rhode Island - 2.07%

45. Massachusetts - 2.19%

44. Connecticut - 2.34%

43. North Dakota - 2.37%

42. Wisconsin - 2.44%

41. Hawaii - 2.47%

40. Pennsylvania - 2.55%

39. California - 2.56%

38. Minnesota - 2.64%

37. Alaska - 2.65%

36. Delaware - 2.67%

35. Nevada - 2.68%

34. Illinois - 2.69%

33T. West Virginia - 2.70%

31. Ohio - 2.72%

30. Colorado - 2.73%

29. Virginia - 2.76%

27. New Mexico - 2.92%

26. New York - 2.86%

25T. Iowa - 2.89%

25T. Montana - 2.89%

23.  Arizona - 3.00%

22. Michigan - 3.01%

21. Maryland - 3.07%

20. Wyoming - 3.09%

19. Missouri - ​3.18%

18. Florida - 3.22%

17. Indiana - 3.26%

16. Nebraska - 3.27%

15T.Kentucky - 3.29%

15T. Louisiana - 3.29%

13. South Dakota - 3.35%

12. Texas - 3.42%

11. Kansas - 3.45%

10. North Carolina - 3.63%

9. Arkansas - 3.91%

8. Oklahoma - 3.94%

7. Idaho - 4.09%

6. South Carolina - 4.13%

5. Georgia - 4.20%

4. Tennessee - 4.45%
3. Alabama - 4.81%

2. Mississippi - 4.99%

1. Utah - 6.56%


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