A rethink on shunning sin

For as long as investors have been bringing moral concerns to bear on the stock market, two industries have loomed large as societal scourges to be avoided: alcohol and gambling.

But as the universe of socially responsible investing (SRI) expands and matures, debate is brewing as to whether traditional rationales for these age-old taboos still pass muster. As a result, the future of these bedrock criteria, embraced for decades by conservative and liberal investors alike, is increasingly uncertain.

"Alcohol and gambling have remained – until this year – standard SRI exclusionary screens across the industry," writes Peter Kinder, president of KLD Research & Analytics, in an e-mail.

But changes are afoot, he observes, as screens seem to be evolving away from categorical bans on these industries to what Mr. Kinder terms a "more normal appraisal" in which vice peddlers are held to largely the same standards as other businesses.

Later this week, Pax World Funds is expected to announce whether shareholders have repealed a 35-year ban on alcohol and gambling-related investments. The initiative stems from management's request for "flexibility to make decisions based on a company's entire social responsibility profile" with a goal of making "the social screens more relevant and meaningful in a changing world."

Observers say the Pax initiative, which could overhaul the oldest social screen used in mutual-fund investing, has kicked off some lively discussion within SRI circles about how to engage so-called "sin stocks." What remains open to debate, however, is whether investors' moral standards have shifted – perhaps amid pressure to earn bigger returns – or if strategies to influence corporate behavior are simply keeping up with the times.

Pax's initiative may not be unique for long. Although Calvert Social Investments has no immediate plans to review its sin screens, "the exact [screening] language that we've been living by for a number of years isn't necessarily carved in stone for eternity," says Bennett Freeman, the company's vice president for social research and policy.

Just as Calvert broadened its screen for weapons manufacturers last month to make it more flexible, Mr. Bennett says, "legacy commitments" on alcohol and gambling could potentially be revamped as part of a probable review of all social screens in the next two or three years. Meanwhile, other issues such as climate change and human rights enjoy priority.

"Alcohol and gambling are just not what we're looking at and working on every day here," Bennett says. "The significance of those issues has diminished as the whole universe of issues that we examine has expanded."

To be sure, alcohol and gambling still incur serious social costs. About 3 percent of Americans display signs of a gambling addiction, according to the National Council on Problem Gambling. Nearly 5 percent struggle with alcohol abuse, according to the National Institute on Alcohol Abuse and Alcoholism.

Even so, more SRI funds are likely to follow Pax's lead by reconsidering whether a hands-off approach to alcohol and gambling stocks still makes sense, according to David Vogel, a business ethicist at the University of California at Berkeley, and author of "The Market for Virtue." In his view, these screens reflect a value system that no longer resonates with most ethical investors.

Bans on "gambling and alcohol come out of more of those early religious roots," Vogel says. In the 1920s, Methodists began shunning firms whose stock in trade was to market one vice or another. In 1971, two Methodist ministers institutionalized those concerns (among others) when they founded Pax, the first publicly available SRI mutual fund.

"I can't imagine that there are many social investors now who believe that a company engaged in those two things is inherently irresponsible," Vogel says. If Pax drops its ban, "I think it might lead other funds to rethink their negative screens."

But others read a different message. Moves to make screens more flexible allow for more thoughtful analysis and better assessment of a company's overall social impact than a simple formula or industry ban could deliver, according to Timothy Smith, president of the Social Investment Forum, a network of socially responsible investment companies.

"The moral concerns about alcohol and gambling are as strong as ever," Mr. Smith says. "These aren't products that make a positive social impact." In revising its screen, he continues, Pax "is actually looking at the complexity rather than making a narrow moral judgment."

For Pax's part, CEO Joe Keefe declined to comment because the issue is currently under shareholder review. He did, however, address the rationale for a screen review in an August interview with Pax's newsletter, "Connection."

"In 1971, SRI was largely a negative strategy that individuals used to avoid certain so-called 'sin' stocks [e.g., alcohol, tobacco, gambling, and weapons]," Mr. Keefe told the newsletter. "Today, 35 years after Pax World was founded, SRI has evolved and is more focused on impacting corporate behavior and promoting social change through a variety of investment strategies."

Finances could also be a factor. Pax's three funds have largely failed to keep pace with average mutual-fund industry returns over intervals of one, three, or five years, according to data from fund-tracker Morningstar. In one particularly painful episode, Pax last year reluctantly divested its profitable stake in Starbucks when the coffee giant struck a deal with Bourbon distiller Jim Beam and triggered a requisite "sell" in accordance with a zero-tolerance policy for companies that make alcoholic products.

Meanwhile, vices are paying dividends. The Vice Fund, which seeks out alcohol, gambling, tobacco, and defense stocks, has beaten the market with returns in excess of 18 percent on average over the past three years.

Still, observers doubt that pressure for higher returns is driving Pax's initiative. The reason: Alcohol and gambling are small sectors when compared with sectors such as oil. Though SRI funds have paid a price for their social standards in recent years, those lower returns can be traced to underweighted plays in the energy sector where booming oil stocks have given unscreened funds a leg up, says Jay Falk, president of SRI World, a Brattleboro, Vt., research firm.

In Mr. Falk's view, the driver for rethinking these traditional screens is a set of shifting moral values among ethical investors. Although outright avoidance is still an approach that investors appreciate on tobacco stocks, he says, investors are now likely to tolerate alcohol and gambling producers in their portfolios as long as the companies model responsible conduct.

"The alcohol screen as it has been applied in the past should really be reconsidered," Falk says. "There's nothing wrong with the production of alcohol. It has everything to do with the use of it." He says a company that sponsors anti-drunk-driving programs, for instance, would be more acceptable than one that doesn't, and instead markets aggressively to youth.

Some mutual funds, however, still regard alcohol and gambling as inherently troublesome products. The socially conservative Timothy Plan promises, for instance, "to screen out investments in cultural and moral pollution," including alcohol and gambling stocks. Similarly, the more liberal Citizens Funds also screens out all alcoholic beverage producers as well as companies for whom gambling is "a main line of business."

Another fund family, Domini Social Investments, makes sure none of its holdings derive "significant revenues" from alcohol or gambling.

"When you look at alcohol, tobacco, and gambling, you can see there is a fundamental problem there," says Jeff MacDonagh, SRI portfolio manager at Domini. "A corporation sells products to the customers ... and then the customers pay for it. They give this company money, and they get harmed in return."

Sin screens aren't on the verge of disappearing altogether. "There are enough investors who feel strongly about alcohol," Kinder says, "that I don't see a major move into such securities by mutual funds relaxing their screens."

Still, times are certainly changing when Calvert, the nation's largest SRI fund family, praises a beer company's wastewater disposal practices. Based on this environmental plus and workplace considerations, Bennett says, "One could think it would not be socially irresponsible to be investing in Anheuser-Busch."