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November 01, 2005
Counting Stars: Top Morningstar Ratings Bespeak Strong Performance for SRI Funds
    by William Baue

Of the 60-odd broadly-screened socially responsible investing funds tracked by, three earn 5-star ratings and 12 earn 4-star ratings from Morningstar.

For individual investors assessing mutual fund performance, the first stop is often the Morningstar rating, which ranges from 5 (better) to 1 (worse). Of the 60 or so broadly-screened socially responsible investing (SRI) funds tracked by, a quarter earn 5- or 4-star ratings from Morningstar. The three 5-star SRI funds include two large-cap funds, one from a SRI shop (Calvert Large Cap Growth Fund--ticker: CLGAX) and another from a mainstream firm (Neuberger Berman Socially Responsive Fund--NBSRX). The Winslow Green Growth Fund (WGGFX), which inhabits the other end of the spectrum as a small-cap growth fund from an environmental specialist, is the most recent addition to the ranks of 5-star SRI funds.

"There are more large-cap SRI funds than anything else, so you'd expect more of them to get higher ratings," explains Morningstar Analyst Bill Rocco, who covers several of the SRI funds. "In the domestic large-cap space, there are a lot of good SRI choices, but it's tougher in the smaller-cap space, and in the international space, it's really tough."

Morningstar 5
and 4 star SRI funds

The list of 12 broadly-screened SRI funds tracked by with 4-star ratings bears this out, as it includes no international funds and only two mid-cap funds--Ariel Appreciation (CAAPX) and Pax World Growth (PXWGX). The list does include several large-cap funds (such as the Sierra Club Stock Fund--SCFSX), a moderate allocation fund (Pax World Balanced--PAXWX), and a couple of intermediate-term bond funds (such as the Parnassus Fixed-Income Fund--PRFIX). As well, the 4-star list encompasses a few religious funds with broad screens that not only exclude so-called "sin" sectors (such as tobacco, alcohol, and gambling) but also employ positive screens for proactive corporate social and environmental performance. These funds include the Aquinas Growth Fund (AQEGX) and the New Covenant Balanced Income Fund (NCBIX).

Launched in 1985, Morningstar ratings got significantly revamped in 2002 by introducing a new measure of risk-adjusted return and by replacing broad asset-class groupings with narrower peer-group categories, such as large-cap growth funds or intermediate-term bond funds.

"Within each category, there's a bell-curve distribution of star ratings," Mr. Rocco told

In other words, 10 percent of funds in each category receive 5-star ratings and another 10 percent receive 1-star ratings on the other end of the bell, 22.5 percent receive 4-star ratings and the same amount receive 2-star ratings, and the bell bulges with 35 percent receiving 3-star ratings.

Also in 2002, Morningstar implemented separate ratings of different share classes within a fund portfolio due to their diverse expense structures (Morningstar's vigilance on expense ratios is renowned.) Separating share classes complicates the situation--for example, broadening the scope of this article to include institutional share classes would add the Calvert Social Investment Bond Fund (CBDIX) to the list of 5-star SRI funds. Other factors further confound the situation.

"There are a number of funds on the SRI borderline--do you count them?" asks Mr. Rocco. "Do you count religious funds?"

Adding the more narrowly-screened funds tracked separately by (as well as narrowly-screened religious funds) would expand the list of "socially conscious" funds (as Morningstar calls them) with 5-star ratings to include two PIMCO funds (PRFAX and PTSAX) and the Amana Growth Fund (AMAGX).

Stepping back to assess the utility of 5- and 4-star ratings, it is important to remember that they provide an initial indication of strong performance but do not tell the whole story.

"The star ratings are certainly important to consider when looking at funds, but there are lots of reasons to look beyond the star ratings and lots of other factors to assess," said Mr. Rocco. "Even though funds get their star ratings within a group, not every fund in the group is the same, and some fund structures can be advantageous in different market conditions."

"For example, I think the Neuberger fund is a good fund, but it's crucial to understand that it pays a lot more attention to foreign stocks and to small- and mid-caps than your typical large blend fund, a strategy that has been advantageous in recent years because foreign and smaller caps have outperformed domestics and larger caps," Mr. Rocco explained. "This doesn't necessarily mean it's a better funds in absolute terms, but it does mean that any kind of backward-looking statistical measurement of performance will rank it higher until there's a market trend reversal."

Mr. Rocco also notes that Morningstar's time horizon, which looks at three-, five-, and ten-year performance when available, misses out on shorter-term changes that could be significant.

"You can have a manager change--some great manager could take over a fund, but the current record's not hers," he points out.


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