SRI stands for socially responsible investing. Historically, however, many have perceived it to mean "sickly returns indeed."

Times have changed. This article looks at the performance of SRI funds, across 12 different Morningstar categories, over the past five years as of June 30, 2010. The data used in this study is drawn from Morningstar Principia.

SRI mandates restrict a mutual fund's ability to select securities in several ways. For example, a common mandate requires that an SRI fund avoid companies involved in tobacco products and/or alcoholic beverages. Another common SRI mandate shuns companies in the gambling industry. Furthermore, some SRI funds may seek only to invest in companies that engage in environmentally sound practices or whose hiring practices are deemed to be fair.

Deciding whether to invest in an SRI fund is not a direct function of the fund's performance, but rather a philosophical commitment on the part of the SRI investor. That said, it's difficult to imagine that an investor is unconcerned with performance and other fund attributes.

This article studies four attributes of SRI funds: performance, portfolio turnover ratio, portfolio expense ratio and portfolio tax-cost ratio. The purpose of this article is not to promote or discredit SRI. Rather, it simply reviews how SRI has behaved in recent years. Of course, some people will care, and some won't. SRI is important to some people and a non-issue to others.

Those who do care will be glad to learn that SRI funds are leaving behind their reputation for underperforming. In fact, over the last five years SRI funds have performed about as well as their non-SRI counterparts, with a lower turnover ratio and a better tax-cost ratio.

OTHER MEASURES

First, let's look at performance. The first step was to separate SRI funds from non-SRI funds. I let Morningstar be the judge of that. Mutual funds coded as SRI were put in one bucket, while non-SRI funds went into another bucket.

The next step was to filter the funds into discrete groups using Morningstar categories. So, for example, all U.S. equity large-blend funds formed one distinct group that contained both SRI and non-SRI funds.

The final step filtered out funds that exceeded certain thresholds with respect to certain portfolio attributes (i.e., percentage of portfolio in U.S. equity, non-U.S. equity, bonds and cash). This last step created a high degree of homogeneity among the SRI and non-SRI funds in terms of portfolio composition.

At this point, the analysis between SRI and non-SRI began. Of course, in every category there were more non-SRI funds than SRI funds.

A comparison of five-year performance reveals that SRI funds-in the aggregate-compete favorably against non-SRI funds (see "Performance Myth," on page 128). Among the 12 fund categories, non-SRI funds had statistically higher performance in only three buckets-U.S. equity mid-cap blend, U.S. equity small-cap growth and moderate allocation funds This analysis shows that SRI funds do not dramatically underperform their non-SRI counterparts-at least over the past five years.

OTHER MEASURES

So it seems that SRI funds have been getting a bad rap as far as raw performance is concerned. Let's take a look at several other portfolio attributes.

* Portfolio turnover ratio. One important portfolio attribute that can materially affect performance is turnover ratio. Examining the average turnover ratios shows that in all but one case, SRI funds had lower ratios (see "As the Fund Turns," at right). In four cases, the turnover of SRI funds was statistically lower (at the 80% of higher confidence level). This finding squares with intuition. Because of their mandates, SRI funds don't have as many companies to choose from, so it's not surprising that they have lower turnover.

* Portfolio expense ratio. As shown in "Price Point," on page 130, SRI funds tend to be more expensive when investing in mid-cap and small-cap U.S. equity funds, intermediate U.S. bond funds and moderate allocation funds. The primary reason for the lower expense ratios among non-SRI funds is the presence of index funds. Index funds typically have lower expense ratios than non-index funds, and very few SRI funds are index funds.

* Portfolio tax-cost ratio. Finally, I compared the five-year tax-cost ratio of SRI and non-SRI funds. Tax-cost ratio is calculated by Morningstar and is a measure of tax efficiency, where the lower the ratio, the better. As shown in "Taxing Matters," on page 130, SRI funds are much more tax efficient. In every case but one, SRI funds had a lower (i.e., better) tax-cost ratio. In five categories, the tax efficiency of SRI funds is statistically lower than their non-SRI counterparts. As noted earlier, SRI funds generally have a lower turnover ratio, which likely contributes to their superior tax efficiency.