By John Vineyard

The concept of socially responsible investing is a darling of people who want to believe that politics should trump economics, or that economics is inherently inadequate as a measure of human activity. They believe that by applying certain tests or screens to their investment holdings they can be more ethical than the ordinary run of investors, and that perhaps by leaning a bit into the wind of unbridled capitalism, they can influence the world in a positive way. It’s no surprise that this philosophy of investing appeals to certain academics.

If you’re like most academics, you don’t have the time or inclination to be your own investment adviser, and it makes sense to invest a good chunk of your portfolio in mutual funds, such as those offered by your university’s retirement plan. Among these choices are likely to be some socially responsible funds. The range of choices among such funds has grown steadily over the past two decades, and about 200 operate now. Although the total amount of retirement assets invested in them is just a small portion of all mutual-fund investments, the number of socially responsible funds now available has grown enough to be fairly daunting.

While most of these funds reflect causes associated with the political left, some exist for a wide variety of perspectives. There are antiabortion funds, Lutheran funds, Christian Science funds, Muslim funds, and fundamentalist Christian funds. Their selection criteria range from a few very specific investment restrictions, such as no tobacco stocks, to others with general guidelines about doing good, and to others with quite elaborate and extensive limitations on where they will invest money.

Most socially responsible funds state that their primary objective is to earn a good return, subject to their selection constraints. They typically use one of three different approaches. They may seek out companies they deem suitable, they may exclude companies they deem unsuitable, and they may engage in various forms of shareholder activism. Some funds enact restrictions that do not absolutely exclude companies operating in certain endeavors or industries, but limit the total percentage of the fund’s assets that may be held in such investments.

An important resource on the whole field of socially responsible investing is the Web site of the Social Investment Forum. It features tables showing the various screening criteria, and a page comparing the funds, showing total assets under management, performance returns, and fees, with links to each fund’s own site.

What about the success of socially responsible funds from an investment point of view? On this I take an agnostic position. But basically, the more we restrict the universe of possible investments, the harder it becomes to match the performance of the broad market, and the harder it becomes to enjoy the benefits of diversification that come from owning a wide range of investments.

Rigorous screening of investments is expensive, and so the more research done to separate wheat from chaff, the bigger the management fees. Studies have shown varying results for socially responsible funds, but the fact remains that the specific circumstances regarding which screens were used and when they were applied make selection based on recent performance quite problematic.

In the long run, higher fees have to mean lower performance, on average. In the long run, less diversification has to mean higher risk, on average. But the long run is a long time, longer than the yardstick of almost any performance report. Even comparing two competing funds from two competing managers who say they use the same criteria may not produce a meaningful measure of management skill or the impact of their selection screens, because of a wide range of uncontrolled factors. And finally, there is the tough old fact that past performance is only a very limited predictor of future performance.

You also need to take a few other considerations into account. One is that the various criteria now fashionable may or may not match your objectives. Another is that a yes-or-no decision about holding a particular stock is really a very weak link in the overall process of corporate governance. The decision to avoid owning common stock in a particular company, for example, will have very little to do with how the shares are valued on the market, since most investors’ chief criteria of valuation is the future profitability of the company.

Even in the unlikely case that a large number of institutional investors could be brought together to divest themselves of holdings in some bad actor so that the share price was driven down, one has to face squarely the practical fact that by temporarily driving down the price of those shares, one would be providing an opportunity for those whose views are opposite to yours to snap up those shares at bargain prices! Some investors mistakenly believe that by buying shares in, say, GE, they are in some sense giving money to that company. Except for new shares in an initial public offering, this is a fallacy.

Another point to consider is that there is a potential for an incestuous linkage between the foundations, funds, and the boards that constitute the universe of people interested in socially responsible investing. Although this possibility may feel like a positive factor for some investors, from the view of a seasoned market observer, such associations tend to foster a kind of groupthink.

Since people in these groups may tend to hire each other because they all agree on noninvestment issues, they therefore may not be as rigorous as they should be in examining their own assumptions. For example, despite the fact that recent medical research strongly suggests that moderate consumption of alcohol is a major health benefit, the great majority of socially responsible funds exclude companies that produce alcohol. And although the overwhelming majority of people would agree that at least in some circumstances the nation has a right to defend itself, most of these funds also exclude investment in defense-related industries. So socially responsible investing is a blunt instrument.

One of the classic dilemmas is whether it is better to hold the shares in a company whose policy you might want to change so that you can engage in shareholder activism, or not to hold the shares. There is a strong possibility that rather than avoiding the bad actors, you might have more impact if you purchased their stocks and used proxy motions, shareholder actions, and similar pressure to influence their behavior. But just as not owning shares in a bad actor doesn’t really hurt that company, owning shares in a good actor, chosen by whatever criteria, doesn’t really reward that company either.

As a cold-hearted economist, I would argue that more social good is done by holding the shares of ethical companies that succeed because they efficiently fill an economic need than by not owning shares of companies whose policies one dislikes.

If you are among the many people on campuses who believe that capitalism itself is inherently evil, it’s both inconsistent and ineffectual to use socially responsible funds at all, because of the deeply interrelated nature of all investment and economic activity.

A practical alternative to investing in these funds is to concentrate on your particular interests and make direct contributions of time and money to those particular causes, candidates, and charities, so that you keep a better rein on the use of your resources and get more feedback about the impact of your work. Instead of paying higher management fees for socially responsible funds, it might be more productive to use less-expensive index funds and donate the savings to specific causes of interest to you, or to predetermine some portion of your investment returns to be used for your particular social goals, many of which cannot be addressed by any one fund.

John Vineyard, C.F.A. formerly an investment officer at Cornell University, left academe in 1992 to become president of Sunlake Investment Management, an investment-counseling firm in Ithaca, N.Y.