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Alison Ringwood
Final Paper - Sustainable Corporations
Socially Responsible Investing Through Mutual Funds
Abstract
Institutional investors are increasingly engaging in SRI strategies. This increased engagement, specifically through mutual funds, has the potential to change the current corporate landscape in the U.S. The types of individuals and households who invest in mutual funds are prime candidates for people who could be interested in SRI, especially with increased access to information. There are tested methods and strategies that mutual funds can use to engage in SRI, but these methods are still being developed and improved. In addition to being done for social and environmental responsibility, SRI is being increasingly shown as a profitable investment. If powerful institutional investors like mutual investors can demonstrate to corporations through their investment choices and institutional activism that sustainability is profitable, there may be hope for the planet and people without losing profit.
Introduction
The growing discussions around sustainable corporations address the issue that our current corporate structure is so driven by profit-based goals that critical environmental and societal rights are being sacrificed at a dangerous rate.
Fortunately, there has been a movement towards creating and exploring alternative business methods. Benefit corporations or b-corporations, is a new business form in which the corporation has a commitment to social responsibility in addition to obtaining a return on investments. “By retaining traditional business purposes and the requirement of pursuing general public benefit, the benefit corporation allows entities to pursue a dual mission of both profit and social good .” The fundamental idea behind b-corporations is referred to as the triple bottom line or the 3-P model: people, profit, planet. This concept of melding profits with social responsibility and environmental concerns is a powerful idea that is being discussed and molded, but has not yet come to fruition.
Investors are a key component to the success of a business. The current corporate structure is concerned with shareholder wealth maximization and short term profits. The business judgment rule enables companies to make whatever decisions are necessary to ensure the company is profitable and providing its investors with a return on their investments. Logically, this appeals to investors who are hoping for their investment to turn a profit. Sustainable corporations are too often viewed as business forms that would sacrifice profit for social responsibility and be of no interest to investors. For the sustainable business sector

2 to continue to grow, investors are needed. This is where socially responsible investing, or SRI, is crucial.
The argument supporting sustainable corporations is that shareholder concerns are evolving as the market for sustainable business practices is expanding and becoming more profitable. As Neil Minow stated, “there’s not a bright distinction between what used to be social policy issues and straight shareholdervalue concerns.” Profits and social responsibility do not need to be addressed as an either or issue. An increase of investments in business that meld profit and social responsibility would enable such business to flourish, and provide them with a necessary backbone. Thus, socially responsible investing is a powerful tool with the capability to change the current business entity landscape in the United States.
SRI is especially powerful through institutional investing, specifically mutual funds. Due to the dominating presence of institutional investors in the current corporate landscape, and due to the types of people investing in mutual funds, SRIs through mutual funds have the capability to have a significant impact on increasing the presence of sustainable corporate practices.
The Power of Institutional Investing
In the current United States business entity landscape, approximately twenty-two trillion dollars of revenue comes from public corporations. The types of investors investing in these public corporations have shifted dramatically from individual to institutional investors. As of 2009 , institutional investors controlled seventy-three percent of the outstanding stock of the largest one thousand U.S. public companies. It was sixteen percent in 1965, thirty-eight percent in 1980, forty-nine percent in 1990, and sixty-one percent in 2000. “The ten largest institutional owners of each of the top 25 U.S. companies hold together on average
28.9 percent of the company’s voting stock.”
Institutional investors have the capability to be very powerful investors and they wield this power. In the 1990s , corporate boards of prominent corporations such as General Motors and American Express, changed their governance structure and divested businesses due to pressure from institutional investors. Since the
1980s, when institutional investors started to become more prevalent, there have been evolving strategies of institutional activism. Most recently, in the 2000s, the strategy has been for institutional investors to follow the recommendations of proxy advisory firms such as Institutional Shareholder Services. This has resulted in shareholder proposals addressing governing matters such as shareholder nomination of directors and majority voting for directors to receive majority support. Since these matters significantly impact management, there has been a trend of management reform in response to this pressure from institutional investors.

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There are a variety of types of institutional investments. As illustrated by the chart, mutual funds account for the largest percentage of institutional investments.
As of 2006, mutual funds specifically, held approximately twenty-seven percent of
U.S. public equities. Therefore, when it comes to analyzing the potential impact of institutional SRI, mutual funds allow for a more focused case study of their potential.
Mutual Funds - Background
Mutual funds are a form of investment vehicle, in which funds from multiple investors are collected and pooled together to invest in a group of stocks, bonds, money market instruments, and similar assets. Mutual funds are operated and managed by professional “money managers,” who invest these pooled funds in an effort to provide investors with capital gains and income. There are many advantages to mutual funds for individuals and small investors. Many mutual funds have low minimum purchases. By pooling the money from multiple investors, mutual funds allow investors with more limited funds to gain access to investments that otherwise would only be available to large investors. Mutual funds enable investors to own a much wider mix of investments then they would be able to invest in on their own. This creates a diversified portfolio of equities for smaller investors.
Diversification increases the likelihood for a return on an investment, because different types of investments perform differently. A more profitable investment can help offset a less successful one. In short, mutual funds give smaller investors more bang for their buck.
Each investor is considered a shareholder, and each shareholder participates proportionally in the gain or loss of the fund. A professional fund manager, often referred to as the fund manager, selects where to invest these funds. Fund managers must be registered investment advisers, which means there is

4 government oversight and stricter regulations monitoring how the shareholder’s money is being invested. The income and profits from invested funds are not taxed and instead treated as pass-through taxation if they fulfill the following Internal
Revenue Code Requirements : investment diversity, limited ownership of voting securities, most of the income is distributed is by investing in securities and currencies, net losses are not passed through to investors but are retained by the fund to offset future gains, and the dividend incomes are reported on shareholders’ tax returns. All mutual funds must be registered with the Securities and Exchange
Commission, “SEC,” and are subject to the extensively detailed regulations established in the Investment Company Act of 1940.
There are also a variety of disadvantages to investing in mutual funds.
Mutual funds have additional fees and expenses that shareholders must pay for, which reduce the fund’s returns and performance. Income from mutual funds is less predictable, since the returns from such a diversified portfolio can rapidly change.
Shareholders also have less control over timing of recognition of gains, since returns are distributed on a set schedule. Lastly, shareholders have no opportunity to customize where there money is being invested. This is especially troublesome, since the percentage of households that invest in mutual funds has exponentially increased since 1990. See the graph on the following page.
Mutual funds are an especially powerful type of institutional investment because of the amount of investment funds mutual funds are accountable for as twenty-seven percent of all institutional investments. As of the end of 2013, there were over fifteen thousand mutual funds in the United States, with combined assets of seventeen trillion. Roughly sixty percent of assets in 401(k) plans and individual retirement accounts were invested in mutual funds. If this type of investment money, most of which is intended for long-term goals, is invested with an SRI focus, this could drastically change the business landscape. B-Corporations or sustainable corporations that take a triple bottom approach could become some of the most heavily invested and profitable companies.

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SRI Through Mutual Funds – motivated by the individual investors
Individuals who invest in mutual funds come from a variety of backgrounds and demographics, and they represent a wide variety of views and opinion. The following three graphs come from a sample of 6,000 mutual fund investors. The first graph represents the average marital status of mutual fund investors. The second graph represents the average age. The third graph represents the average education level.

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This wide variety of demographics demonstrates that the kinds of people investing in mutual funds are likely to have a wide variety of opinions and views. Diversity in individual investors has similar advantages to a diverse portfolio. It allows for a wide variety of the types of investments people would be interested in seeing in their mutual fund’s portfolio. SRIs are a type of investment that may not be ideal for everyone, but it is almost indisputable that SRIs are appealing to a portion of mutual fund investors. This makes it feasible for there to be mutual funds entirely focused on SRIs. Not every single individual investing in a mutual fund has to want a mutual fund focused on SRIs to increase the presence and impact of sustainable corporations. As long as some do, seeing as mutual funds are such a significant form of institutional investments, this would increase funding and investments to support sustainable corporations.
The likelihood of increasing SRI through mutual funds is also supported by the fact that individuals cite retirement as their primary reason for investing in a mutual fund. The graph below shows the percentage of people from the sample group of 6,000.
Short termism and quick returns is discussed as one of the main theories dominating how corporations are currently run. The idea of immediate and short term profit means companies make business decisions that are not concerned with long term success. Instead of reinvesting profits to create a machine that would take fives years to make, but once made would significantly reduce production costs, the company will just continue to produce the item at a cheaper rate with current fossil fuel technology. This way, the profit from the product is immediately seen. Yet, retirement funds are intended to remain untouched for years. Mutual fund investors are not looking for that immediate turn around in profit. It would actually be beneficial for a mutual fund investor to have an investment where the profits were slightly delayed and then exponentially increased in the future. Investing for

7 retirement and not expecting an immediate dividend is where the concept of profit, planet, people becomes realistic. If taking sustainable steps can increase profit, then the issue of short-term returns is negated by the investment being intentionally created for a long-term goal.
Mutual funds are also a great vehicle for SRI, because mutual fund investors are willing to take greater risks than individuals who do not invest in mutual funds.
The top graph shows the level of risk households who do own mutual funds are willing to take when investing, while the bottom graph shows the level of risk households who do not own mutual funds are willing to take.
As demonstrated by the charts, homes owning mutual funds are much more willing to take risk than homes not owning mutual funds. This is likely due to the fact that mutual fund investors proportionally share in the profits and losses of the mutual fund’s investments. On an individual level, such investors are not risking as much of their personal capital which makes them willing to take on slightly riskier investments. Mutual fund investors are going to be much more willing to invest in new technologies and alternative business practices that have an average to below average probability of giving them a return on there investment. The concept of sustainable corporations has the potential to be profitable, but the business world is still creating and designing these methods. Investors who are willing to take risks by investing in these new types of methods are the types of investors who will

8 enable sustainable corporations to go from a concept to a creation. Additionally, when these new technologies or new practice methods prove to be successful, it is these investors who will see the most profit from investing early.
This idea of mutual funds using SRI techniques to focus on longer-term success and delayed returns for great profit may also be appealing to individual investors since most mutual funds become less profitable over time. Very few mutual funds outperform index funds over time.
The individual and household investors of mutual funds are ideal investors for SRIs. They offer a diverse range of demographics and interest, their primary reason for investing is for long-term goals not short-term returns, and they are willing to take a little risk in their investing. There is a market for mutual funds focused on SRIs that can be profitable to the investors, the fund manager, and the planet.
The Current Trend of Socially Responsible or Sustainable Investing
SRI through mutual funds is not a brand new concept, nor is it purely an idea.
There are already mutual funds engaging in SRI. In 1995 , there were fifty-five mutual funds with twelve billion in assets that were participating in SRI. Now, there are approximately four-hundred and ninety- three mutual funds with five-hundred sixty-nine billion in assets. There are a variety of research and investor groups like the Forum for Sustainable and Responsible Investments, “ USSIF ,” that focus their work on SRIs.
The USSIF defines SRI as sustainable, responsible, and impact investing, a slight variation from the normal socially responsible investing/ investments.
Specifically, the USSIF defines SRI as “An investment discipline that considers environmental, social and corporate governance (ESG) criteria to generate longterm competitive financial returns and positive societal impact.” This definition of
SRI supports the idea that mutual funds are a great vehicle for change, through investments, to the current unsustainable corporate structure.
The USSIF not only looks at mutual funds, but all funds under professional management. They stated that at the end of 2013, more than one out of every six dollars under professional management in the United States was invested according to SRI strategies. This amounted to a total of 6.57 trillion dollars. The below chart shows the total net assets that were incorporated using USSIF’s ESG factors.

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From 2012 to 2014 alone, SRI under professional management grew by seventy-six percent, and increased by a total of 3.74 trillion dollars. Calvert is an example of a
SRI focused fund company, and is 13.4 billion in total net assets. SRI fund companies are not the piteous investment groups some people may believe them to be.
One reason for this significant increase in SRI funds is attributed to an increase in investors’ understanding of company costs and how these cost impact long-term performance. This increase in understanding has been helped by improved cost disclosure in shareholder reports and other fund publications, the greater attention financial media has given cost, and the ease and accessibility to online information. “ Investors always thought that time horizons for ‘sustainable’ investments had to be longer in nature in order to take advantage of mispriced externalities, but that is changing.” Research is showing that companies with high ratings for ESG factors “consistently have a lower cost of capital in terms of both debt and equity.” So even though mutual fund investors show a trend of being more willing to take slightly more risks with their investments than non-mutual fund investors, they may not really need to. In a study conducted by Deutsche Bank, published in a paper on SRI, claimed that 100% of the firms with high ratings for corporate social responsibility exhibited both market and accounting-based financial outperformance.
The Methodology of SRI
There are a variety of approaches reportedly used by mutual funds and other institutional investors to make SRI. Four of the main categories that investors are most concerned with are environmental stewardship, alternative energies, consumer protection, and human rights. Currently, climate change remains the most significant environmental factor when it comes to assets. For the first time in 2014, the amount of money was tracked that was intentionally diverted from companies using excessive amounts of fossil fuels and contributing to global harm. It accounted for 13.5 billion in institutional investor assets at the beginning of 2014.
There are four strategy methods that companies use to actually practice sustainable investment, these will be explained as if they were being applied by a mutual fund when determining what companies should be included in their portfolio as an SRI mutual fund:

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(1)Negative or exclusionary. A company would be excluded from a mutual fund’s portfolio based on specific ESG criteria.
(2) Integration. A fund manager would systematically and explicitly include the risks and opportunities of ESG qualities of companies into their traditional financial analysis.
(3) Positive/ Best-in-Class. A fund manager would chose companies for positive ESG performance relative to industry peers.
(4) Impact Investing. In single or multi-themed mutual funds, the fund manager would specifically invest in companies related to sustainability.
From a sample of 159 SRI mutual funds, a company looked at what percentage of the mutual companies funds went towards SRI and how they used these SRI funds.
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The above chart shows that the primary SRI strategy used by these mutual funds was positive, or directly investing in companies that exhibited positive qualities towards the listed factors. Almost none of these surveyed mutual funds exclusively used exclusion from companies as a method to engage in SRI strategy. This may also be though, because the data was taken from financial reports which are more focused on what companies are doing/ who they are investing in rather than what companies they are not investing in. The chart also shows that environment was the greatest SRI factor, almost every one of the 159 mutual funds screened for environmental issues. The factor of the least concern to these mutual funds was executive pay.
Conclusion
Socially responsible investing can be a powerful tool, especially when wielded by influential institutional investors like mutual funds. History has shown that the business landscape can rapidly change. In approximately twenty years, institutional investors went from representing a minority of shareholders in U.S. public corporations to representing the dominant majority of shareholders.
Changing the current investment structure has the potential to drastically change business methodologies in the next twenty years. Mutual funds are a potentially ideal investment vehicle for SRI. One of the main reasons SRIs have increased is because of increased access to information and disclosure requirements. If mutual funds would clearly disclose to their investors what companies their assets are being invested in and why these companies are being chosen to be part of their portfolio, individual investors may be more aware and choosy of where they are investing their money. It is these kinds of steps that must be taken to directly influence the direction of the corporation towards a more sustainable track.