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 SocialFunds.com,
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
SocialFunds.com, 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."
The list of 12 broadly-screened SRI funds tracked by
SocialFunds.com 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
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).
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 SocialFunds.com.
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.
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 SocialFunds.com (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
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.
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