By Michael Kramer, Managing Partner & Director of Social Research at Natural Investments LLC
2012 marks the 20th anniversary of the NI Social Rating (the Rating), the nation’s first sustainable and responsible (SRI) mutual fund rating system that made its initial appearance in Investing from the Heart, the 1992 book by Natural Investments’ founder Jack Brill.
The GreenMoney Journal has featured the NI Social Rating in every issue over the last decade as an important feature of their Mutual Fund Performance Chart.
With the mainstreaming of green consumerism in American society and the growing frustration over the ethical and bottom-line failures of corporations, particularly within the financial services industry, the popularity of values-based investing continues to increase. As such, it has also spawned products from well-known global conventional fund families that own the most responsible companies in an industry or that seek out sustainability pioneers rather than entirely avoiding companies involved in objectionable industries or practices. This approach is known as Best-in-Class.
The Rise of Best-in-Class
Traditionally, SRI has been practiced by managers that exclude companies in certain target industries or companies that engage in undesirable practices. In recent years, however, more funds are taking a best-in-class approach to holdings selections or are investing in companies that commit to the path of responsibility in the environmental, social, and governance (ESG) arena. Rather than excluding entire sectors, these managers select companies within such industries that show the best track record of ESG performance. This can sometimes include companies that excel at disclosure of their practices, even if such practices are offensive. Rewarding companies for their transparency, as well as for how they compare to their industry peers, caters to the large number of investors who wish to own the whole market, and who may still believe that optimal financial return might otherwise be compromised through avoidance screens. While some funds conduct ESG analysis internally, data is widely available from social research firms such as IW Financial that ranks major companies in each sector according to both common and customizable criteria. In addition, some funds (e.g., Calvert Large Cap Value) intentionally hold oft-excluded companies for the explicit purpose of engaging them in dialogue and filing shareholder resolutions in the hopes of shifting their policies and practices towards justice and sustainability.
Revised Ratings
The NI Social Rating is ideally based on manager self-reported information via a questionnaire which covers 55 distinct criteria in the areas of research methodology, ESG screening, shareholder advocacy, and community investing for cash positions. In some cases, fund personnel choose to not complete the questionnaire as requested, in which case prospectus information is used to determine the Rating. However, such written policies tend to lack specificity, and in many cases efforts in the areas of advocacy and community investing are excluded from the documents, so the Rating is conducted on a best-efforts basis. In the past year, several funds completed the questionnaire, which resulted in modifications to their Ratings. It is also important to note that financial performance is not part of a funds’ Rating.
New Alternatives Fund, 30 years old and one of the first green economy funds in the country, has been upgraded to a five-heart fund (the Highest Rating) given the breadth and depth of its industry-leading comprehensive screening practices. New Alternatives received 94 percent of all possible points available for ESG avoidance and affirmative screening.
Other funds saw their Ratings reduced after their practices were confirmed. Ariel Investments’ four SRI funds were reduced from three hearts to two. While this manager actively engages in corporate dialogue and shareholder resolutions, its exclusionary screens are minimal – tobacco and firearms – though it does consider some environmental, community, and diversity issues in its stock selection. The company does not engage in community investing.
Parnassus Funds saw its Rating lowered from five to four hearts, primarily because of its limited exclusionary screens. Parnassus primarily uses a best-of-class approach rather than exclusion, and includes companies in sectors such as fossil fuels and military contracting that are typically excluded from most SRI funds.
Portfolio 21, though an industry leader in its integration of ecological criteria in selecting investments, saw its Rating reduced from five to four hearts because it does not examine many factors in the areas of labor, corporate governance, community relations, or human rights issues. In addition, the company does not introduce or support shareholder resolutions.
Newer Ratings
Boston Common, a leading SRI separate account manager since 2002 which launched its International Fund in late 2010, received four hearts due to its leadership and level of activity in shareholder advocacy along with a high number of ESG criteria used in holdings selection.
Dimensional Fund Advisors is a conventional global manager that initiated its U.S. Sustainability Core, U.S. Social Core, and International Sustainability Core funds a few years ago. Though the firm declined to complete the questionnaire, they did verbally reveal their approach, which includes the exclusion of the traditional sin stock categories along with some additional exclusionary and best-in-class environmental criteria. This, combined with a lack of involvement in shareholder advocacy or community investing, resulted in a Rating of two hearts.
Schroders is another conventional global manager that has indicated that it is using ESG criteria for its five-year-old Schroder Emerging Market Equity Fund, making it the first-ever SRI emerging market fund. Historically, it has been challenging to find suitable companies or obtain verifiable ESG data in emerging market countries. Schroders, while not committing to any specific ESG criteria via prospectus or marketing material, indicates that it has a dedicated ESG team that has been integrating social research data into its analysis since 2009. The fund has no formal exclusionary screens and does not engage in community investing, though it will engage corporate management on ESG issues. The fund has been awarded one heart (the Lowest Rating).
Sustainable Asset Management (SAM), a global manager known more for its role in establishing criteria for the Dow Jones Sustainability Indexes, also runs a Sustainable Climate and Sustainable Water fund. SAM uses a best-in-class approach and no exclusionary ESG screens, and it does engage management in dialogue on ESG issues. The funds have been awarded two hearts.
Best Funds Overall
There are 55 distinct criteria in the NI Social Rating. Mutual Funds scoring in the top quintile receive five hearts and include: Calvert, Domini, Green Century, New Alternatives, Pax World, and Walden. Four-heart fund companies include Appleseed, Boston Common, Neuberger Berman, Parnassus, Portfolio 21, and Winslow.
Best Funds for ESG Criteria
Top quintile performers in the integration of environmental, social, and governance factors into holdings selection include: Calvert, Domini, Green Century, New Alternatives, Pax World, and Walden
Also Boston Common and Neuberger Berman scored well in this category.
Best Funds for Shareholder Advocacy
The shareholder advocacy score is based on level of dialogue with management and the introduction and support of others’ shareholder resolutions and public policy activity. Leaders in advocacy and public policy include: Boston Common; Calvert, Domini, Green Century, Pax World and Walden.
Other funds active in this realm are: New Alternatives, Parnassus, and Sentinel.
Best Funds for Community Investing
Broad-sector mutual funds earn points in this category based on how they allocate cash positions. Some opt to directly support community development banks, credit unions, and loan funds and others purchase bonds in low-income communities, while some own agency securities or loans.
Two premier dedicated community investment funds are CRA Qualified Investment Fund and Access Capital Community Investment Fund. Though by design they do not hold equities, these funds focus on maximizing social and environmental impact in their debt portfolios. CRA even allows major shareholders to geographically target loans. These two firms do integrate a ESG criteria in their holdings selection, but while their unique niche doesn’t warrant a high overall score, they are among the leaders in the Community Investing category, which includes: Access Capital Strategies, CRA Qualified, Domini, Pax World, and Walden.
Methodology and Laggards
There are many approaches to integrating values into financial decisions, and there are many “shades of green” in the sustainable and responsible investment industry. One reason the NI Social Rating was developed in 1992 was to help the general public distinguish those funds that do minimal avoidance screening from those that conduct comprehensive ESG integration and are involved in advocacy and community investing. While certainly any company that bases holdings selection in part on any non-financial factor should be applauded, investors should read fund literature closely to examine the specific nuances of each approach.
Though there is disagreement on the use of the best-in-class approach within the SRI industry, the Rating weights the best-in-class approach lower than the “purer” approach of avoiding problematic companies and sectors or championing sustainability leaders because companies that cause social or environmental harm should not be rewarded simply for doing less harm than their peers. Being a force for “less bad” in the world is a poor standard that has less impact than being a force for positive change. While some SRI firms intentionally hold certain objectionable companies in order to engage them in dialogue, many hold them without initiating such conversations but still want to be known as SRI funds. Funds with the lowest NI Social Rating include: Ariel, Dimensional Fund Advisors, Gabelli SRI Green Fund, Schroders Emerging Market Equity, Sustainable Asset Management.
Though numerous, the NI Social Rating does not rate funds that use religious values to determine holdings selection. Such funds use very specific criteria, so the Rating does not compare such values to the more common secular approach, even though the portfolios of such funds use some similar criteria as managers that don’t base their decisions on religious tenets.
A complete listing of the NI Social Rating of domestic SRI funds and more information on our methodology can be found at http://www.naturalinvestments.com
Article by Michael Kramer, M.Ed., AIF® is Managing Partner and Director of Social Research at Natural Investments LLC, an investment advisor registered with the SEC that has been exclusively devoted to sustainable and responsible investing since 1985. Specific funds and fund companies mentioned in this article are provided for informational purposes only andtheir inclusion is not to be construed as investment advice.
