Emphasis on Tech Stocks Makes ‘Socially Responsible’ Look Risky

The largest “socially responsible” mutual funds have beaten the Standard & Poor’s 500 index for more than three years by embracing technology companies and snubbing those that sell liquor, tobacco and other products deemed harmful.

Yet some analysts question how much longer these do-good funds can do so well.

Many of these funds have thrived by focusing on high-priced computer-related stocks. If these stocks falter, the socially responsible fund boom may turn out to be harmful to the funds’ investors.

“The funds have less refuge if there’s an extended market downturn,” said Emily Hall, an analyst with Morningstar Inc., a Chicago-based company that tracks mutual funds.

The Domini Social Equity fund, the largest of these funds, had 42% of its $1.3 billion in computer-related shares as of Feb. 29. By comparison, only 33% of the benchmark Standard & Poor’s 500 index is composed of such stocks.

At the same time, about 17% of the S&P;’s assets are in industrial companies such as Caterpillar and energy companies such as Entergy, which have seen far less dramatic returns than technology. Only about 5% of the Domini fund is so invested.

But to investors, the Domini fund’s performance speaks for itself. It returned 26% a year on average in the five years ended Feb. 29, outdistancing the S&P; by 0.8 percentage point a year.

The number of socially responsible funds has jumped to about 57 from 23 at the end of 1993, according to Morningstar. The Vanguard Group, the No. 2 mutual fund company, and the Teachers Insurance and Annuity Association-College Retirement Equities Fund plan to offer such mutual funds later this year.

Each socially responsible fund tends to define “responsible” a little differently. The nine-year-old Domini tracks an index of 400 companies, 250 of which are part of the S&P; 500. Excluded are businesses that derive at least 2% of their revenue from armaments, alcohol, tobacco and gambling. Nuclear power companies also are out.

Companies that have employee diversity and comfortable working conditions and don’t pollute are favored.

Such screening tilts toward computer-related companies, which tend to be generous with stock options and are relatively pollution-free. Domini’s three largest holdings are Microsoft, Cisco Systems and Intel, which also are the three biggest companies in the S&P; high-technology composite index.

As Americans embraced wireless communication, the Internet and computers of all kinds in the last five years, the S&P; high-technology index returned an average 48% annually, including reinvested dividends.

Microsoft and Cisco also were the largest holdings at year’s end for the Dreyfus Premier Third Century fund, the second-largest socially responsible fund. It has outpaced the S&P; 500 by 2.6 percentage points annually on average in the last five years.

The socially responsible funds’ returns have also been helped by avoiding tobacco stocks, which have performed dismally amid scores of lawsuits seeking damages from cigarette companies for costs of treating smoking-related illness.

Almost all of the funds have no investment in Philip Morris, the world’s largest tobacco company. Once prized for its steady earnings, Philip Morris now has a stock price 67% below its high, trading at 1994 levels.

Many in the investment business dismiss social investing as a marketing gimmick.

“The whole premise is undefinable,” said Douglas Eby, co-manager of the Torray Fund, which no longer owns Philip Morris shares. “Some would say making excess profits is socially irresponsible. . . . It’s not a legitimate approach to investing.”

To supporters such as Barbara Zack, a 38-year-old New York publishing executive who bought into the Domini fund in October, the ascendance of social investing makes perfect sense. Good companies avoid problems by looking beyond the bottom line, she said.

“Having a long-term view beyond just making money this week epitomizes a well-run company,” she said. “The easiest decisions to make at the moment may not be the best long-term decisions.”

She shrugs off the rich valuations of the Domini fund holdings, which trade on average at 40 times the past year’s profits. (The S&P; 500 has a price-to-earnings ratio of 30.)

Zack said she is a long-term investor who will sit through ups and downs. Moreover, traditional valuations may no longer hold, given how computers, software and the Internet have boosted economic growth. “Maybe the paradigm has shifted,” Zack said.

* Paul J. Lim’s mutual fund column does not appear today.