Has social investing lost its way?

Many ethically minded investors would think twice before funding an industry known for misleading ads, scant environmental accomplishments, and boardrooms where just about everyone is white.

So what happens when such charges are directed at socially responsible investing? A host of SRI mutual-fund managers are fuming in the wake of a scathing report on their industry. At the heart of the controversy lies a concern as stinging as it is sweeping: Has the term "socially responsible" become meaningless in a fast-growing industry that invests in just about anything?

"To put it plainly, if the SRI industry were a corporation, it wouldn't qualify in a rigorously screened portfolio," says the Oct. 15 report from the Natural Capital Institute (NCI) in San Francisco. "Either the industry has to reform in toto (or rename itself), or that portion of the industry that wants to maintain credibility must break off from the pretenders and create an association with real standards, enforceability and transparency."

What's more, the report charges, pressure to beat such mainstream performance benchmarks as Standard & Poor's 500 has led SRI funds to own shares in 90 percent of firms on the Fortune 500 list. When Wal-Mart, McDonald's, Pfizer, and Microsoft are all deemed socially responsible, who's left to screen out? These criticisms are especially notable because they come from Paul Hawken, an icon of the sustainability movement and founder of the NCI.

Those charges aren't entirely fair, argue professionals whose fortunes rise and fall by the integrity of their investment decisions. The report relies on a crude methodology of lumping together funds from across the globe to paint an unfair picture of the industry for American investors, they say. And it overlooks how funds have used their clout as stakeholders to improve mainstream corporate practices across a range of industries. Still, it has lifted the lid off a hot discussion that's been simmering privately on the investment world's back burner for years. That means change may be brewing in the SRI industry.

"No one likes to have this kind of discussion in public," says Doug Wheat, director of SRI World Group, an information clearinghouse for ethical investors. "But just because people may be defensive, that doesn't mean they're not trying to take seriously what they believe are good points."

Case in point: the Sierra Club Mutual Funds. Billed as an opportunity to "invest in our planet's future," these funds took a beating in Hawken's report for owning no alternative-energy companies and no companies "that address the environment in an innovative or proactive way." Instead, the report alleges, portfolios include steakhouses and companies that make such inconsequential items as surge protectors or in other cases contribute to urban sprawl.

"Mr. Hawken is missing the concept," says Garvin Jabusch, director of the Sierra Club fund family. The funds invest in Starbucks, for instance, in part because the company measures its environmental footprint by tracking its water output. Dell Computer also wins his praise for its recycling programs. As a matter of practice, Sierra Club funds avoid risky "microcaps" that are long on ideals and short on track records. They instead reward major corporations that make consistent improvements.

Still, Mr. Jabusch concurs with Hawken's core critique. "We disagree with his tenor and his method, but we do agree there's a need for standards," he says.

Sierra Club funds already hold themselves to a higher than average standard by screening out all mining, gas, oil, and timber firms, Jabusch says. Such eco-friendly funds might prefer an "ERI" label, for environmentally responsible investing. Such a brand might be more meaningful than SRI, he suggests, especially if ERI funds could agree on specific screening standards that set them apart from the pack.

More than 600 funds worldwide claim the SRI label, according to the report, but investors can't be sure what it means, since the definition varies from case to case. Hawken's solution is to reclassify funds according to the approaches they use.

For example: There could be "rock the boat" funds, whose managers buy shares in problematic companies, such as big polluters, so they could press for reform as shareholders. Other funds might get special standing for owning pure plays, that is, firms whose products make a positive dent in global problems. An array of new categories would help ethical investors figure out what they want their investments to accomplish.

Such a categorizing system has been under discussion over the past five years, according to Anita Green, director of social research at Pax World Funds. "The industry is getting to a point where it has to tighten up its definitions. But we haven't found a way to do it that wouldn't confuse the issue more.... We don't want to do a disservice by sending out all these broad categories" that might further complicate the landscape, she notes.

Pax World laid the groundwork for today's hodgepodge SRI industry 33 years ago. At first, antiwar activists in the United Methodist Church envisioned an investment vehicle that did not support the military. Yet by the time Luther Tyson and Jack Corbett put the idea into action, their definition of "socially responsible" had expanded to include not just peace activism but also environmental protection and concern for the working poor.

Today, according to the NCI report, the industry encompasses more than 100 funds in the US, 367 in Europe, and about 125 in other parts of the world. In general, SRI funds use one or more of three approaches: screening out corporate bad apples, investing in community development projects, and advocating as shareholders for good corporate policies.

Still, techniques and criteria vary widely, from a Roman Catholic fund that considers contraception immoral to a humanist one that regards condom distribution as a moral imperative for population and disease control. And not everyone sees such variety as a bad thing.

"They all play their role," says Timothy Smith, president of the Social Investment Forum, an industry trade group. He suggests people might be better served by funds that clearly say what they mean by "socially responsible" than through a ratings system proposed by Hawken, which indicates how "pure" a fund is. That amounts to little more than "tiers of self-righteousness," he says.

Whether or not the industry needs universal standards, the philosophical debate touched off by Hawken's report runs even deeper. For years, industry players have taken pride in proving that an ethical portfolio can meet or beat Wall Street's performance benchmarks. But Hawken suggests this goal has stripped the enterprise of its integrity. "We believe that striving to attain the highest rate of investment return is a direct cause of social injustice and environmental degradation as it consistently leads to externalization of costs on the environment, the future, workers or other peoples," the report says.

But such a notion holds little sway with SRI fund managers who refuse to compromise the financial bottom line. "I believe [a smaller return on investment] is a luxury that a lot of institutions, foundations, and people investing for their retirements aren't able to embrace right now," says Mr. Smith.

"We simply do not have the luxury of waiting for utopia, adds Ms. Green of Pax World Funds. "The rest of us are trying to make this work in the real world."

Some of the report's other proposals also appear unrealistic, investment experts say. For example, its call for greater transparency to show how screening criteria are applied to particular companies would amount to a surrender of valuable intellectual property, says Bob Walker, a vice president who oversees screening and advocacy at The Ethical Funds Company in Vancouver, British Columbia.

Ultimately, change may be in store for the SRI industry - but nothing will happen overnight. "I think we're all waiting to see what our investors want," Mr. Walker says, "not what the Natural Capital Institute wants."