Socially (Ir)responsible Mutual Funds

For many investors, social responsibility is an important factor in their choices of mutual finds. There is, however, a whole other side to the equation: socially irresponsible investing. Let's take a closer look at what irresponsible investing is and how this investment strategy emerged. In Socially Responsible Mutual Funds, we discuss what socially responsible mutual funds are, how they came to be and why investors may want to choose them. Here, we look at the opposite.

As the name suggests, socially irresponsible mutual funds hold baskets of stock from companies with business or activities that are considered bad for society. These activities might include things such as the distribution or production of alcohol, tobacco and weapons. Sometimes referred to as sin stocks, these companies might also engage in unethical business practices such as child labor or environmental negligence.

Unlike socially responsible investors who hold strong convictions about sinful stock, socially irresponsible investors are focused on making significant returns, and are indifferent to social issues and the unethical actions of corporations. This isn't to say that people investing in sin stocks support the use of questionable business practices; these investors simply believe that certain companies will always have opportunity to profit from people's consumption of so-called immoral products.

As an illustration, let's consider Altria Group (formerly known as tobacco giant Phillip Morris). Because responsible investors are opposed to making money off what they consider to be a deadly habit, they avoid investing in tobacco stocks. Tobacco firms, however, have traditionally fared well during slowdowns because smokers find their habit hard to quit.

Within the classification of socially irresponsible mutual funds, there are different names for funds with different strategies. For example, "leisure funds" invest a large portion of their assets in casinos and alcohol and tobacco companies but also maintain a measure of diversification. Like many socially responsible mutual funds, leisure funds prevent over-specification of many sector funds. The Fidelity Select Leisure Portfolio, for example, invests in restaurants such as McDonald's in addition to casino hotels such as MGM Mirage. Another example of a socially irresponsible mutual fund is the Vice Fund. Unlike leisure funds, the vice fund invests solely in the casino, defense, tobacco and alcohol industries, which may not provide adequate diversification for some investors' tastes.

If supporters of socially irresponsible funds believe that the underlying companies will display strong earnings in both good and bad markets, why are these funds hard to find today? Socially irresponsible mutual funds became popular in the 1980s in response to the increased popularity of socially responsible funds; however, more recently these funds have largely disappeared from the market. The reason could be that these funds border a very thin line between insult and profit.

For example, Morgan Funshares, which began in 1989 and was liquidated in 2003 with the death of its founder, was originally called Morgan Sinshares. Because the original name was not politically correct, it risked offending potential investors. As an alternative to socially irresponsible mutual funds, many well-known equity mutual funds hold sinful stock along with the stock of mainstream companies such as banks, retailers, technology and manufacturing firms.

A further reason for the disappearance of sinful funds is the changing views of people in regards to health and the environment. This can slow business for sin stock companies. In addition, the Environmental Protection Agency is continually approving heightened restrictions in its environmental laws and regulations. Companies are increasingly being required to reduce emissions and to adopt practices that provide for sustainable development. As a result, companies that have historically been heavy polluters may be forced to clean up their acts – and empty their wallets.

Your beliefs will determine whether sinful stocks should have a place in your portfolio. The screening process of any investment, however, should not be aimed specifically at a firm's social responsibility – or lack thereof. Instead it should be about selecting quality companies that, regardless of the industries in which they operate, have good earnings, management and high-growth potential.