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Fran Hawthorne: How Socially Responsible Funds Define Virtue

Fran Hawthorne is the author of The Overloaded Liberal: Shopping, Investing, Parenting, and Other Daily Dilemmas in an Age of Political Activism. Hawthorne has been a writer or editor at FortuneBusinessWeekInstitutional Investor, and other publications. She is the author of three books on health care and investing, including Inside the FDA and the award-winning Pension Dumping.

Let's say you try to eat food grown without chemical fertilizers, and you want to follow that principle in your investing as well. Consider Group Danone, the manufacturer of Dannon Yogurt. "Group Danone is the largest purveyor of organic dairy products in the world," according to Amy Domini, chief executive of Domini Social Investments, which runs the benchmark Domini 400 Social Index. So Group Danone is a buy?

Not so fast. Amy Domini also points out that "twenty percent of its business is bottled water, and about half of that is to people with potable water" – that is, Danone is wasting millions of barrels of petroleum to make plastic water bottles for Americans who could safely drink their own tap water. Furthermore, in 2007 the company bought a manufacturer of infant formula named Royal Numico, and remember the consumer uproar when Nestle tried to push its powdered infant formula in developing countries in the 1970s and 1980s?

Now should you put your money in Group Danone?

When Domini and other socially responsible mutual funds first developed the concept of socially responsible investing, back in the 1970s, it seemed easy enough: No tobacco, liquor, gambling, or weapons. But as the funds dug into more issues – and attracted more customers – the complications have grown. Today, most managers look at the labor relations, employee benefits, environmental record, treatment of workers in low-pay countries, product safety, impact on the local community, management structure, and shareholder rights of every company they consider investing in.

Then, the question becomes: How pure do they want to be? If their investment standards are too high, the funds may not find any companies that qualify. However, if the standards are too low, how is socially responsible investing any different from ordinary investing?

The Overloaded Liberal book cover Calvert Group, for instance, has a checklist of 24 criteria, grouped under seven categories. Under the "product safety and impact" category, Calvert requires that companies "produce or market goods and services that enhance the health or quality of life for consumers," "respond promptly to correct problems with product safety," "avoid animal testing, or when testing is legally required, reduce the use of animals," "demonstrate integrity in their advertising and labeling," and "maintain quality control and customer satisfaction." To qualify for Calvert's "workplace" category, companies must "demonstrate inclusive diversity policies [with] fair treatment of all employees"; "provide strong labor codes" including "comprehensive benefits" and "a record of sound employee relations"; and "have extensive employee health and safety policies" with training and "a positive safety performance record."

Here's the punch line: All the stocks in Calvert's 22 SRI mutual funds must satisfy all 24 requirements in the checklists of all seven categories. "That's a lot" to demand, Paul Hilton, Calvert's director of advanced equity research, admits.

(I'll say. I think that if I found a company so saintly that it met all 24 requirements, I wouldn't just buy the stock; I'd marry the CEO.)

The strict lines have cost Calvert some investments Hilton wanted, like Liz Claiborne Incorporated. In the early 2000s, Claiborne "really was good for human rights, supply chain management, women's issues, environmental issues," Hilton recalls. "We had a very positive relationship with the company." Other consumer advocates praised the manufacturer for joining the Fair Labor Association set up by President Bill Clinton to enforce labor standards in overseas sweatshops. So what was Calvert's problem? Claiborne had one label called Crazy Horse, "which was the source of a lot of protests from the Crazy Horse family and a lot of American Indian peoples." Calvert had to dump the stock. (Luckily, by 2007 Claiborne had gotten rid of the offending line, and Calvert could bring it back.)

Hilton claims the Claiborne case is a rarity. Even with the 24-item checklist, he says two-thirds of the companies he evaluates pass master, leaving an investor plenty of choices.

Still, should one line of clothing eliminate a $4.6 billion company? Should bottled water outweigh all the good organic products Danone sells? (Domini said no and rejected Danone.)

To me, the key is flexibility. I think Calvert goes too far in demanding that every stock meet all 24 sub-criteria; Domini takes a better approach in juggling the relative importance of Danone's water and organic businesses (although a customer might disagree with Domini's final verdict). It's okay to have 24 criteria, or even 124, as long as there's some give and take. For instance, an SRI manager could require that a company meet two-thirds of the criteria. Or there would be weighted voting, with some criteria more equal than others.

Some funds try to gain flexibility by seeking what they call "best in class." The idea is that if you want to diversity across the broad economy, to have a toehold in a lot of industries, you're going to have to hold your nose and find the least-bad in some of those industries, even if they might not meet all your standard criteria. Joseph F. Keefe, president and chief executive of the Pax SRI fund family, likens this to grading on a curve: "We try to find companies whose performance, programs, and policies are better than their peers," he says. Domini does that for most industries, but it still has a total ban on tobacco and Big Oil.

"There's no company that's going to be perfect in every single score," sums up Cheryl Smith, chair of the Social Investment Forum. "If they are, you haven't looked hard enough."