The Problem with Socially Responsible Mutual Funds

I’m often asked what I think about socially responsible mutual funds (or socially responsible investing in general).

To explain, let me introduce you to Jim.

• Jim is an accountant. He has never had a super high income, but he has been consistently employed since finishing college 30-something years ago.
• Jim has saved diligently throughout his career, and his index-fund portfolio is now sufficiently large that he expects to be able to retire within the next few years, despite having no pension.
• In other words, Jim has accumulated a significant sum of money.
• Every so often, Jim experiences some misgivings about having that much money. He recently read that his seven-figure net worth means he has more wealth than 99% of other people in the world.
• Jim also has some misgivings about several of the companies that are owned by his index funds.
• Jim’s annual budget does include a non-trivial amount of charitable giving each year, but the reality is that in order to meet his goals, he has to keep most of his money.
• Jim wants to feel better about having a lot of money. That is, he wants to continue to have a lot of money. But he doesn’t want to feel bad about it.

Jim has a need.

There are a lot of Jims.

What does the financial services industry do when it sees a lot of people with a given need/desire? It creates a product.

Socially responsible mutual funds are that product. Socially responsible mutual funds exist to let you feel better about having money (i.e., not giving it away). The fund industry usually doesn’t want you to give your money away. If you do, they don’t get to collect a percentage (in most cases).

This isn’t to say that socially responsible funds are a bad thing. From a “doing good in the world” standpoint, a socially responsible fund might have a beneficial effect in that it might exercise its voting rights more frequently — or more frequently in line with your views — than typical index funds.

Conversely, if the fund’s way of being socially responsible is simply to exclude certain stocks/industries from the fund, it is giving up its power to vote to change the behaviors of those companies/industries. That is, as a shareholder, a fund has influence. If it chooses not to own those companies, it gives up any potential influence it might have. You may see where I’m going with this. As a socially responsible investor, I would like a fund that owns all firms (i.e., an index fund) and which votes to make the changes I want to see. I do not want a fund that goes out of its way to give up its influence over the companies I would most like to influence.

Unfortunately, whether or not socially responsible funds actually have a positive societal effect is not generally super important from the perspective of the fund company (or, in most cases, from the perspective of an advisor recommending the fund). As long as you feel better about owning this fund as opposed to another one, mission-accomplished.

It is normal to have some misgivings about having far more wealth than almost everybody else in the world.

And it is clear that the most effective way to alleviate those misgivings is to give away more money — either directly to people who need it more than we do, or to charitable organizations that fight against the thing(s) we find unethical.

But, unfortunately, there’s a limit to how much we can give while still reaching our goals. With our current retirement system (in which few people have pensions and Social Security doesn’t cover everything), if you want to retire someday with a middle class level of spending or higher, you must accumulate a pile of money — and keep it for yourself.

It is also normal to have misgivings about owning shares of companies that do things you find unethical.

Yet owning those shares and using your vote as a shareholder is precisely how you can attempt to influence those companies. Unfortunately, as mutual fund investors, it is the fund managers that must vote on our behalf, and we have limited information as to how fund managers vote their shares. And the “socially responsible” funds (i.e., the funds with a stated mission of working for positive change) go out of their way to give up their right to vote on such issues, because doing so allows people to feel better about owning the funds (i.e., it makes them more marketable).