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Many of these funds prospered in the 1990s, when the basic material stocks that they frowned upon swooned, while the favored sectors—mostly technology and financial stocks, which were considered “clean investments”—did great. But the technology and communications bust of 2000–02 knocked out one of SRI’s pillars, and now the crash in financial stocks has destroyed the other. Despite much hype to the contrary, socially responsible stocks, as measured by major broad-based SRI stock funds, have significantly underperformed the market this decade, and some of the most aggressive pension funds that use “responsible” screens—such as the California Public Employees’ Retirement System—have taken some of the largest hits.
“Investing in socially responsible stocks just because they are socially responsible is not—underline not—a valid investment thesis,” says Steven Pines, a senior investment consultant for Northern Trust. Many of the largest socially responsible mutual funds, including a leading benchmark, the Domini Social Index, have been laggards for years. The Sierra Club’s high-profile social fund, which had regularly trailed the benchmark S&P 500 index by about 6 percent a year, liquidated in December, a victim of its poor performance record. As recently as last November, 76 out of the 91 socially responsible stock funds were underperforming the Dow, according to the investment research company Morningstar.
“This crisis highlights the limitations of social research methods,” says Dirk Matten, who holds the Hewlett-Packard chair in corporate social responsibility at York University’s Schulich School of Business. Although some socially responsible research models are more sophisticated than others, particularly ones that eschew simplistic screens, social investors have downplayed the actual business of a business, including whether it can create jobs and spread wealth, while overweighting what Matten believes are more symbolic concerns, such as announced programs to combat climate change.
Sometimes corporate social responsibility can mask or come at the expense of responsibility to shareholders. Fannie Mae, for instance, was named the No. 1 corporate citizen in America from 2000–04, based on datacompiled by the top U.S. social research firm, KLD Research and Analytics in Boston. Well, it does have a great diversity program.
As recently as mid-2008, three of the top eight holdings by the leading social investing organizations in the country were financial stocks: AIG, Bank of America, and Citigroup. AIG was praised for its retirement benefits and sexual diversity policies; Bank of America strove to reduce greenhouse gas emissions and promote diversity; and Citigroup donated money to schools and tied some of its loans to environmental guidelines. The stock prices of all three companies tanked in 2008.
From South Africa to the Shop Room Floor
The catalyzing event that changed pension funds from boring retirement pools to political operators was the international boycott of apartheid South Africa in the 1980s and the campaign to limit investments in companies that did business with Johannesburg. The success of the campaign energized baby boomers, now entering their prime earning years, who were committed to “making a difference” with their dollars. Taking a cue from these social investors, pension funds began dabbling in what came to be known as economically targeted investments—injecting money into communities or projects that addressed social ills, with healthy returns becoming a secondary concern.
The earliest pension fund social investing initiatives were often cobbled together during crises, with little appreciation for unintended consequences. In the 1980s, for example, the Alaska public employee and teacher retirement funds loaned $165 million—35 percent of their total assets—for the purpose of making mortgages in Alaska. When oil prices fell in 1987, so did home prices in the nation’s most oil-dependent state. Forty percent of the pension loans became delinquent or resulted in foreclosures.
While unions and social investors often work together, their investment strategies are not always in sync. In 1989, under union pressure, the State of Connecticut Trust Funds invested $25 million in Colt’s Manufacturing Co. after the beleaguered gun maker—hardly a favorite of the SRI crowd—lobbied the state legislature to save jobs. Colt’s filed for bankruptcy just three years later, endangering the trust funds’ 47 percent stake.
In the late 1980s, the Kansas Public Employees Retirement System, then considered a model of activist social investing, placed $65 million in the Home Savings Association, after its lobbyists told top officials that this would help struggling segments of the state economy. That investment evaporated when federal regulators seized the thrift. All told, the Kansans wrote off upward of $200 million in economically targeted investments.
Olivia Mitchell, executive director of the Pension Research Council at the Wharton School, has reviewed the performance of 200 state and local pension plans from 1968 to 1986 . She found that “public pension plans earn[ed] rates of return substantially below those of other pooled funds and often below leading market indexes.” In a study of 50 state pension plans during the period 1985–89, the Yale legal scholar and economist Roberta Romano concluded that “public pension funds are subject to political pressures to tailor their investments to local needs, such as increasing state employment, and to engage in other socially desirable investing.” She noted that investment dollars were directed not just toward “social investing” but also toward companies with lobbying clout.
Because of poor returns, these early experiments in economically targeted investments lost their allure. Most states and municipalities steered clear of social investing for a time. That hesitancy eroded during the 1990s, partly as a result of a new strategy employed by organized labor.
With their membership falling, union leaders found it harder to influence companies or politics from the factory floor. The new approach was to ally with social investors and adopt one of their key tactics: lobbying through shareholder resolutions intended to pressure corporations. “The strengthening of shareholder democracy promises to further empower investors to address governance issues such as out-of-control executive pay as well as environmental and social issues such as climate change,” Jay Falk—president of SRI World Group, which advises pension funds on social investing—said in 2007, as the tactic was gaining traction.
Union-led pension funds are also trying to rattle political cages, but they’re running closer to empty every day. Even before the sell-off, in the summer of 2008, while nearly 90 percent of nonunion funds met minimum safe funding thresholds—meaning they had adequate cash on hand to pay their benefits—40 percent of union funds were at risk. “These are high risk numbers even in a steady economy,” writes Diana Furchtgott-Roth, a pension fund specialist with the conservative Hudson Institute, in a recent study. Furchtgott-Roth notes that union fund management practices are opaque, costs are higher than at nonunion funds, and the plans have promised more than they can ever hope to deliver. “When workers entrust their retirement assets to an outside party, it is important that this party’s only interest be achieving the best returns possible,” she argues. “Unions clearly do not do this.”