The risks of "socially responsible investing"

Advocates of "socially responsible investing" (SRI) advocate avoiding companies in certain industries (tobacco, weapons, nuclear energy, tobacco, alcohol), or those whose policies on labor, environment etc are judged to be incorrect, or companies in certain third-world countries. Many mutual funds, both liberal and conservative, offer SRI as a strategy; the performance of such stocks and such funds, especially in the past year, has been dreadful.

Many of these funds prospered in the 1990s, when... 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...

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...

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...

In 2003 CalPERS rejected a recommendation... to invest in the equity markets of four Asian nations—Thailand, Malaysia, India, and Sri Lanka—based on their alleged misdeeds. That was a costly decision, as their stock markets roared in the ensuing years. Another decision to shun investment in China, India, and Russia cost the fund some $400 million in forsaken gains, according to the fund’s own 2007 internal report...

Since California sold its tobacco shares, the AMEX Tobacco Index has outperformed the S&P 500 by more than 250 percent and the NASDAQ by more than 500 percent. That one decision alone cost California pensioners more than $1 billion, according to a 2008 report by CalSTRS...

So what stocks did the California funds buy instead? High on the list were financial stocks, which have been given a green bill of health by social investors... Lehman Brothers, AIG, and other fallen icons... But those losses may pale when the tab comes due for misplaced bets on the boom-to-bust California real estate market. According to a report released last April, CalPERS had 25 percent of its $20 billion real estate assets in the California market, which has declined faster than the real estate markets in most of the rest of the country.

Note - the author of this piece is a fellow at the American Enterprise Institute, so his viewpoint will be a conservative one, but the data itself is probably correct, and the point he makes should be noted.