EXECUTIVE SUMMARY

AS CONCERN FOR THE ENVIRONMENT, SOCIAL ISSUES and corporate governance increases, CPAs may find more interest among their clients in investment strategies and mutual funds that emphasize social responsibility. SOCIALLY CONSCIOUS INVESTORS MAKE DECISIONS by screening for positive and negative issues, shareholder advocacy, community investing and providing social venture capital. Screening is usually the first step to make sure companies don’t produce objectionable products or engage in practices such as discrimination or environmental pollution. AT ONE TIME THERE WAS CONCERN THAT SOCIALLY responsible investing would hurt performance. But several studies laid those concerns to rest. From 1990 to 1998, the Domini 400 Social Index returned 18.54% vs. 16.95% for the S&P 500. Another study found companies that adhered to strict environmental standards created greater market value. EVEN FINANCIAL ADVISERS WHO DON’T SCREEN for social issues are concerned today about corporate governance. Many prefer to avoid companies that are the subject of an SEC inquiry or where there has been a change in senior management. Corporate scandals erode shareholder value, a commodity that’s difficult to restore. INVESTORS WITH MORE CUSTOMIZED SOCIAL screens will find buying individual stocks, as opposed to mutual funds, makes it easier to satisfy their concerns. Mutual funds do their best work in broad screening. For example, it would be difficult to use mutual funds to support companies with good animal rights practices.

CYNTHIA HARRINGTON, CFA, is a financial journalist with 20 years’ investment experience. She began her career as a stockbroker and ended it as the owner and chief investment officer of an asset management firm serving high-net-worth clients. Her work appears in a variety of financial publications. She is a contributing editor of Accounting Today and www.horsesmouth.com, a subscription Web site for financial advisers.

onventional wisdom has long held that stock market investors care only about profits. This attitude began to change in the late 1960s when socially conscious investors banded together to promote the stocks of certain companies. These investors avoided businesses that polluted, discriminated or exploited the third world or had conflicts of interest at the board level. However, they never gained enough momentum to have any significant impact. In 2003 socially responsible investors again are on the rise, and activists and profit-oriented investors alike evaluate a company’s social conscience before investing. The reason is as plain as the Enron on your face—unethical companies drain shareholder value. For CPA financial planners who want to introduce socially responsible investing to their clients, this article provides a look at the foundations on which this investment philosophy is built.

Community investing. A more direct way for clients to create social change is to invest in both the debt and equity of entities that work to bring about such change. Most community investing involves lending to inner city businesses, depositing money in banks that lend in underdeveloped neighborhoods or investing in mutual funds that engage in these activities. The Louisville Community Development Bank, for example, has lent money to local day-care centers, freeing more than 1,000 mothers to fill jobs in the area.

When Georgette Frazer started investing 25 years ago, she says she naturally followed a socially responsible strategy. As a CPA/PFS, CFP with Lifetime Financial Services LLC in Marshfield, Wisconsin, Frazer continues the practice today. She highlights the changes in the industry using the University of Wisconsin’s retirement system as an example. Some 20 years ago students protested, saying the university should put its money into companies that supported positive social issues. Apartheid was a leading issue of the day. The trustees resisted, saying that to avoid certain companies might impair performance and they had a fiduciary duty to seek a high return. “Now they believe social investing is a requirement of their fiduciary duty,” Frazer says.

Frazer is one of a small number of financial advisers who publicly claim to provide advice in this area. Many use the First Affirmative Financial Network, an independent registered investment adviser, in Colorado Springs, for fee-based asset management. FAFN offers separate account and mutual funds programs that meet socially responsible goals to more than 200 financial advisers.

“I LIKE THAT”
Bob Dreizler, CLU, ChFC, started an active tax practice in 1975 in Sacramento, California, that evolved to include financial advice five years later. “I started hearing about socially responsible mutual funds in the early 1980s,” says Dreizler. “I watched with skepticism because I was leery about how well they could do.”

By 1988 Dreizler had fully committed himself to being an expert on this new way of investing. He presented the opportunities to his existing tax and financial planning clients, and they responded positively. “When I told people about the social screens, about avoiding polluters and finding companies with diverse boards of directors that balanced gender and race—all while achieving good performance returns—most clients said ‘Yes, I like that,’” says Dreizler.

Other research confirms that Wall Street rewards socially responsible companies. The Social Investment Forum, a nonprofit organization that provides information on socially responsible investing, gave its 2001 Moskowitz prize to a report titled “Do Corporate Global Environmental Standards Create or Destroy Market Value?” The report’s authors found that companies that adhered to strict standards created greater market value. They looked at 89 U.S. companies in manufacturing or extractive industries that maintained production facilities with a large potential to pollute. Each company chose which environmental standard it would apply. The results may surprise some CPAs. First, nearly 60% of the companies adhered to the same high standard company-wide in every country where they did business, compared with the less than 30% that used the standards of the developing countries where they were located. Second, companies that chose the higher road each commanded approximately $10.4 billion higher market capitalization than those using local standards.

THE IMPORTANCE OF TRUST
CPAs recognize the need for high ethical standards is even more critical today. In a smokestack economy, company assets remained even if management committed fraud in reporting financial numbers. The board paid the fine, changed management personnel and went back to creating value from the hard assets. In the information economy, companies create value from intangible assets. Thus, when trust is gone, the other intangibles disappear. Once vendors won’t extend credit, employees fail to see a bright future and investors abandon the company’s stock, there’s nothing left to trade on. The loss is catastrophic and permanent for those shareholders that hang on until the end.

Far more financial advisers pay attention to corporate governance issues today. James M. Luffman, CPA/PFS of Chas Smith & Associates in Lakeland, Florida, says initially his firm wouldn’t buy tobacco stocks for client portfolios but that was the extent of its advice on socially responsible companies. Today, however, advisers at the 10-year old firm, which manages $300 million in assets, take a dim view of companies subject to an SEC inquiry or where the CEO has quit. “We’ve definitely included corporate governance issues in our sell strategy,” says Luffman. “Before, we would have reviewed our investment decisions when those kinds of problems occurred, but we take a much harder look at it today.”

For CPAs who may want to introduce their clients to the socially responsible approach to investing, FAFN provides its members with access to a full range of socially responsible mutual funds and separate account programs. In the latter case asset allocation is driven by answers on a sophisticated questionnaire that assesses clients’ risk-and-return needs and elicits the details of the personal values they wish their investments to express. FAFN then manages the assets and handles all back-office services.

A WEALTH OF CHOICES
Over the last 20 years the industry has grown from a handful of funds and a few asset managers to encompass enough choices in all asset classes for CPAs to construct a properly diversified portfolio. But it still has a way to go. “We lack an international and short-term bond fund,” says Frazer. “And there are no socially responsible fiduciary standards for insurance companies to allow us to choose insurance products to match the client’s values.”

She says CPAs will find the process of discovering the values clients want to apply to responsible investing a lot like the estate planning process. Frazer determines the client’s risk-and-reward preferences before exploring his or her life goals and values. Then she constructs the investment program to meet both.

Energy companies fall into a gray area. Everybody uses natural resources, so they’re tough to exclude. “One couple didn’t want to buy Exxon because of the Valdez accident so they wanted to exclude all oil companies from their portfolio. We convinced them they needed to own that sector—even if they preferred to avoid Exxon,” says Luffman. “Not owning oil companies is a conflict for clients who own cars. Cars use gas, and oil companies produce that gas.”

CLIENTS FIRST
Now that the market supports diversified investing and chalks up good performance numbers, Frazer expects to see more CPAs offering clients the opportunity to pursue socially responsible investing. “Lots of us got into the CPA profession partly because of the ethics. Integrity was emphasized even in school. Plus we’ve got the drive to do the work of crunching the numbers,” she says. “All this matches our desire to fulfill our fiduciary roles in putting the client’s goals first.” The checklist in exhibit 4, above, lists some of the steps CPAs can take to incorporate socially responsible investment strategies into their practices.