Index Funds With a Conscience
If you like the idea of socially screened funds but are bothered by their tendency to underperform the market, you may be a candidate for a socially screened index fund.
Socially screened funds take a lot of flak. They practice what some call socially responsible investing (a term we'll avoid so as not to imply that other forms of investing are socially irresponsible), by investing only in companies that meet certain social, environmental or corporate-governance standards. Historically, socially screened stock funds have underperformed the market and charged high expenses to boot. So it's not surprising that many serious investors avoid them.
Enter socially screened index funds. These funds combine social goals with the low expenses and relative predictability of index funds. Two such funds stand out for their low expense ratios and encouraging performance -- either of them could take the place of a broad-market index fund in your portfolio.
Vanguard, the popularizer of index funds, offers one of them. Vanguard FTSE Social Index (symbol VFTSX, 800-635-1511) tracks the FTSE4Good US Select index. The FTSE team first eliminates entire industries, such as alcohol, firearms and gambling, then whittles the U.S. stock market down to 400 or so companies with the best labor, corporate-governance and environmental practices. FTSE weights the index to match the sector breakdown of the U.S. stock market, then weights specific companies by market capitalization and liquidity -- that is, the ease with which their stocks trade.
The fund's long-term performance results -- an annualized return of 8% over the past five years -- aren't particularly useful. In late 2005, the fund switched its benchmark from a Calvert index to the FTSE index (Vanguard preferred FTSE's weighting structure). From the time it made the switch through April 30, the fund returned 13% annualized. That lagged Standard & Poor's 500-stock index by an average of two percentage points per year. The fund charges 0.25% per year for expenses.
The other notable fund is actually a hybrid, part indexed and part actively managed. TIAA-CREF Institutional Social Choice Equity (TICRX; 800-223-1200) aims to mimic the Russell 3000 index, which tracks the 3,000 largest U.S.-based companies. The fund invests in companies in the KLD BMSI index, which takes the Russell 3000 universe and screens out about 900 companies based on social and environmental criteria, such as any that make money on alcohol, tobacco, gambling, weapons or nuclear power. TIAA-CREF then actively weights the fund to match certain portfolio measurements of the Russell 3000 in an effort to better replicate its returns.
In part, that active weighting entails matching the growth-value balance of the Russell 3000, which management thinks should boost performance relative to the KLD index and other socially screened funds. Socially screened funds usually concentrate on growth companies, notes Scott Budde of TIAA-CREF, because many industries that typically fall into the value category -- energy and other commodities, for instance -- have a tough time passing environmental screens. Value stocks have trounced growth stocks over the past few years, leading many socially screened funds to underperform. So the TIAA-CREF team boosts the fund's allocation to certain value plays, particularly utilities.
Social Choice Equity gained 15% over the past year, trailing the Russell 3000 by one percentage point and the S&P 500 by two. An older version of the fund that recently merged with Social Choice Equity's retail shares returned an annualized 7% over the five years to April 2, matching the Russell 3000's gains and beating the S&P 500 by one percentage point. The retail share class charges 0.32% a year for expenses.