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United States Government Accountability Office:
GAO: 

Report to the Ranking Member, Subcommittee on Technology, Information 
Policy, Intergovernmental Relations and Procurement Reform, Committee 
on Oversight and Government Reform, House of Representatives: 

June 2012: 

Thrift Savings Plan: 

Adding a Socially Responsible Index Fund Presents Challenges: 

Thrift Savings Plan: 

Report to the Ranking Member, Subcommittee on Technology, Information 
Policy, Intergovernmental Relations and Procurement Reform, Committee 
on Oversight and Government Reform, House of Representatives: 

GAO-12-664: 

GAO Highlights: 

Highlights of GAO-12-664, a report to Ranking Member, Subcommittee on 
Technology, Information Policy, Intergovernmental Relations and 
Procurement Reform Committee on Oversight and Government Reform, House 
of Representatives: 

Why GAO Did This Study: 

Socially responsible investment—-investment made on the basis of 
environmental, social, religious, or corporate governance criteria—-in 
U.S.-based mutual funds exceeded $300 billion in value in 2010. TSP-—a 
$308 billion retirement plan with more than 4.5 million participants-—
currently offers five distinct low-cost investment options, and is 
authorized to offer a service that enables direct participant 
investment in mutual funds outside TSP. GAO was asked to consider the 
value of adding an SRI option to TSP. GAO examined: (1) What 
challenges might TSP face in adopting an SRI option? (2) How would the 
addition of an index fund tracking an SRI index have affected past TSP 
stock portfolio performance? (3) How do the performance and costs of 
SRI mutual funds compare to those of non-SRI mutual funds? 

To analyze the challenges surrounding SRI, GAO interviewed federal 
officials, SRI experts, and representatives of public retirement plans 
that had considered SRI adoption. To examine the impact of adding an 
SRI fund to the existing TSP funds, GAO analyzed monthly benchmark 
return data. To examine mutual fund performance trends and costs, GAO 
analyzed historical summary data on US-based mutual funds. 

GAO provided a copy of this draft report to the Board, the Department 
of Labor, and the Department of the Treasury for review and comment. 
None of the agencies provided formal comments on the report. 

What GAO Found: 

Officials at the Thrift Savings Plan (TSP) and the other public 
retirement plans that had considered socially responsible investment 
(SRI) associated a number of common challenges with SRI adoption. 
While none of these plans were identical to TSP in scope or 
demographics, many plan officials shared similar challenges and 
concerns with TSP. For example, they identified participant demand, 
SRI screening criteria, and costs as the most common challenges. 
Officials at public retirement plans that had adopted SRI cited some 
short-term benefits of SRI, such as providing participants an 
opportunity to invest in accordance with their values, but said that 
the long-term benefits were unknown. 

When compared to the past performance of the TSP stock portfolio, the 
addition of a hypothetical SRI index fund tracking the best-performing 
U.S.-based SRI stock index would not have both increased returns and 
lowered volatility in any allocation scenario that GAO tested. 
Specifically, over the last 20 years, if TSP had included such an SRI 
index fund in its existing stock portfolio, it could have resulted in 
(1) lower returns and lower volatility, (2) lower returns and higher 
volatility, or (3) higher returns and higher volatility, based on GAO’
s analysis of evenly distributed portfolio allocations. The managers 
of the SRI index explained the difference in the index’s performance 
over the last 20 years was a result of having different sector 
weightings than the overall market to align with the fund’s SRI 
strategy. Moreover, the addition of this SRI fund would have resulted 
in overlap with the TSP stock portfolio, and would not have provided a 
substantial opportunity for additional portfolio diversification. 

Figure: Effect of Adding an SRI Index Fund to a Portfolio of the TSP 
Stock Index Funds (1992 to 2011): 

Fund allocation: 
SRI: 33.3%; 
S: 33.3%; 
I: 0; 
C: 33.3%; 
Risk: increased; 
Return: increased. 

Fund allocation: 
SRI: 50%; 
S: 50%; 
I: 0; 
C: 0; 
Risk: increased; 
Return: increased. 

Fund allocation: 
SRI: 50%; 
S: 0; 
I: 0; 
C: 50%; 
Risk: decreased; 
Return: decreased. 

Fund allocation: 
SRI: 25%; 
S: 25%; 
I: 25%; 
C: 25%; 
Risk: decreased; 
Return: decreased. 

Fund allocation: 
SRI: 33.3%; 
S: 0; 
I: 33.3%; 
C: 33.3%; 
Risk: decreased; 
Return: decreased. 

Fund allocation: 
SRI: 50%; 
S: 0; 
I: 50%; 
C: 0; 
Risk: decreased; 
Return: decreased. 

Fund allocation: 
SRI: 33.3%; 
S: 33.3%; 
I: 33.3%; 
C: 0; 
Risk: increased; 
Return: decreased. 

Fund allocation: 
SRI: 100%; 
S: 0; 
I: 0; 
C: 0; 
Risk: increased; 
Return: decreased. 

SRI: Socially responsible investment index; 
S: small capitalization index; 
I: International capitalization index; 
C: Common stock index. 

Source: GAO analysis of annual rates of total return based on monthly 
total return data from Morningstar, Inc. 

[End of figure] 

Looking more broadly at SRI mutual funds-—the most common form of SRI 
in the United States—-GAO found the comparative performance of SRI and 
non-SRI mutual funds to vary by asset class while costs were nearly 
the same. Regarding performance, SRI bond mutual funds had better risk-
adjusted performance than their non-SRI counterparts over the last 15 
years, while SRI stock and balanced funds did not. However, after 
controlling for various factors such as fund size, SRI stock mutual 
funds had better estimated performance as well. Regarding costs, in 
fiscal year 2010, the costs of SRI institutional grade mutual funds 
were similar to their non-SRI counterparts. Although TSP participants 
cannot currently invest in mutual funds through TSP, the Federal 
Retirement Thrift Investment Board (Board) is authorized to offer a 
mutual fund window if it determines that it is in the best interests 
of participants. 

What GAO Recommends: 

This report contains no recommendations. 

View [hyperlink, http://www.gao.gov/products/GAO-12-664]. For more 
information, contact Charles Jeszeck at (202) 512-7215 or 
jeszeckc@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Officials Identified Several Challenges to SRI Adoption and Said the 
Long-term Economic Benefits of SRI Were Unknown: 

Adding an SRI Index Fund Would Not Have Improved Past TSP Portfolio 
Performance in Most Allocation Scenarios: 

SRI Mutual Fund Performance Varied by Asset Class, but Had Similar 
Costs to Non-SRI Mutual Funds: 

Concluding Observations: 

Agency Comments: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Variation of Annual Compound Rates of Return and Standard 
Deviation among Evenly Distributed Allocations of the Best Performing 
SRI Stock Index and Existing TSP Stock Index Funds, 1992 through 2011: 

Appendix III: Additional Information on the Performance of SRI and Non-
SRI Mutual Funds by Asset Class: 

Appendix IV: GAO Contact and Staff Acknowledgment: 

Tables: 

Table 1: Investment Requirements for Existing TSP Funds: 

Table 2: Regression Coefficients on Non-SRI Indicator: U.S. Stock 
Funds, Institutional, Front-load, and No-load Share Classes: 

Table 3: Regression Coefficients on Non-SRI Indicator: U.S. Balanced 
Funds, Institutional, Front-load, and No-load Share Classes: 

Table 4: Regression Coefficients on Non-SRI Indicator: U.S. Bond 
Funds, Institutional, Front-load, and No-load Share Classes: 

Table 5: Coefficient on SRI Indicator in Regression with Annual Report 
Net Expense Ratio as Dependent Variable With and Without Control 
Variables: 

Table 6: Sharpe Ratio SRI and Non-SRI Bond Mutual Funds: 

Table 7: Sortino Ratio SRI and Non-SRI Bond Mutual Funds: 

Table 8: Sharpe Ratio SRI and Non-SRI Stock Mutual Funds: 

Table 9: Sortino Ratio SRI and Non-SRI Stock Mutual Funds: 

Table 10: Sharpe Ratio SRI and Non-SRI Balanced Mutual Funds: 

Table 11: Sortino Ratio SRI and Non-SRI Balanced Mutual Funds: 

Figures: 

Figure 1: Cumulative Growth in the Number of U.S. Open-end SRI Mutual 
Funds, 1952 through 2011: 

Figure 2: Investment Screens Applied by SRI Mutual Funds: 

Figure 3: Number of Public Retirement Plans Identifying Challenges 
Associated with SRI Adoption Similar to Ones Identified by TSP 
Officials: 

Figure 4: Effect of Adding a Hypothetical TSP SRI Index Fund on Past 
TSP Stock Portfolio Performance, 1992 to 2011: 

Figure 5: Annual and Cumulative Returns of the Indices Underlying the 
C, S, I, and SRI Funds, 1992 to 2011: 

Figure 6: Comparison of Annual Net Expense Ratios of SRI and Non-SRI 
Mutual Funds: 

Abbreviations: 

Board: Federal Retirement Thrift Investment Board: 

C Fund: Common Stock Index Investment Fund: 

DB: defined benefit: 

DC: defined contribution: 

ESG: environmental, social, and corporate governance: 

ERISA: Employee Retirement Income Security Act of 1974: 

ETAC: Employee Thrift Advisory Council: 

FERS: Federal Employees' Retirement System: 

FERSA: Federal Employees' Retirement System Act of 1986: 

F Fund: Fixed Income Investment Fund: 

G Fund: Government Securities Investment Fund: 

I Fund: International Stock Index Investment Fund: 

S Fund: Small Capitalization Stock Index Investment Fund: 

SRI: socially responsible investment: 

TSP: Thrift Savings Plan: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

June 26, 2012: 

The Honorable Gerald E. Connolly:
Ranking Member:
Subcommittee on Technology, Information Policy, Intergovernmental 
Relations and Procurement Reform:
Committee on Oversight and Government Reform:
House of Representatives: 

Dear Mr. Connolly: 

Since its inception in 1986, the federal government's Thrift Savings 
Plan (TSP) has become a central component of federal employees' 
retirement savings. Intended to resemble 401(k) pension plans in the 
private sector, TSP allows employees to contribute a portion of their 
current compensation through payroll salary deductions and to allocate 
their contributions and any associated earnings among the available 
investment options. As of February 2012, TSP held about $308 billion 
in retirement assets and had more than 4.5 million participants, 
making it one of the largest retirement savings plans in the United 
States. 

The Federal Employees' Retirement System Act of 1986 (FERSA) 
established TSP and the Federal Retirement Thrift Investment Board 
(Board), an independent agency in the executive branch, to administer 
it.[Footnote 1] The five-member, presidentially appointed Board must 
manage TSP prudently and solely in the interest of the participants 
and their beneficiaries and cannot exercise the voting rights 
associated with ownership of securities in TSP. FERSA also established 
three TSP investment funds: the Government Securities Investment Fund 
(G Fund), Common Stock Index Investment Fund (C Fund), and Fixed 
Income Investment Fund (F Fund). In 1996, Congress authorized TSP to 
broaden its offerings with the International Stock Index Investment 
Fund (I Fund) and Small Capitalization Stock Index Investment Fund (S 
Fund). Since August 2005, TSP participants also have had the option to 
choose one of five lifecycle funds, which diversify participant 
accounts among the G, F, C, S, and I Funds using investment mixes 
tailored for different retirement time horizons. 

Congress has proposed legislation to require TSP to offer additional 
investment options in an effort to give participants and beneficiaries 
greater investment choice. Several of these proposals have sought to 
require TSP to include a responsible investment index fund that would 
track a market index comprised of stocks that were prescreened for 
corporate governance, environmental practices, workplace relations and 
benefits, product safety and impact, international operations and 
human rights, involvement with repressive regimes, and community 
relations.[Footnote 2] Commonly referred to as socially responsible 
investment (SRI), this kind of investment strategy seeks to generate 
long-term competitive financial returns while realizing positive 
societal impact by investing in accordance with one's values or 
certain environmental, social, or corporate governance criteria. 
Investment in SRI mutual funds--the most common SRI vehicle--exceeded 
$300 billion in 2010. Congress asked us to examine the value of adding 
an additional investment option to TSP in the form of an SRI index 
fund. In response to this request, we examined the following questions: 

* What challenges might TSP face in adopting an SRI option? 

* How would the addition of an index fund tracking an SRI index have 
affected past TSP stock fund portfolio performance? 

* How do the performance and costs of SRI mutual funds compare to non-
SRI mutual funds? 

To determine the challenges associated with SRI, we reviewed relevant 
federal laws and regulations related to FERSA and TSP, and literature. 
We also interviewed officials from TSP, the Employee Thrift Advisory 
Council (ETAC), investment management or consultant firms, and a 
nonrepresentative sample of 15 public pension plans. To identify our 
sample, we contacted plans that were signatories of the United 
Nations' Principles for Responsible Investment and employed a snowball 
sampling technique based on recommendations of interviewees. To assess 
how the addition of an index fund tracking an SRI index would have 
affected past TSP stock fund portfolio performance, we identified the 
best performing U.S.-based SRI stock index based on 10-year risk-
adjusted performance data, and analyzed its potential impact on the 
TSP stock portfolio over the past 20 years (1992 through 2011). 
[Footnote 3] Because this analysis is strictly based on past 
performance, this result does not guarantee or imply that the addition 
of an SRI index would have the same effect on future TSP stock fund 
portfolio performance. To determine how the performance and costs of 
SRI mutual funds compared with those of non-SRI mutual funds, we 
analyzed historical performance data for several time periods over the 
past 15 years (dating back from December 2011)--the longest time 
period for which data were available--and cost data from fiscal year 
2010. We focused our analysis exclusively on three share classes of 
mutual funds--institutional, front-load, and no-load--of U.S. 
domiciled open-end mutual funds, which experts identified as the most 
common form of SRI funds.[Footnote 4] To better demonstrate the full 
range of performance and costs trends between SRI and non-SRI mutual 
funds, we analyzed funds by subcategories such as share class, and 
also ran regressions to control for factors such as fund asset size 
and investment strategy. 

We assessed the reliability of the quantitative data used in this 
engagement by reviewing related documentation, interviewing 
knowledgeable officials, reviewing related internal controls, 
comparing to published data, and tracing a selection of data to source 
documentation. Based on this evaluation, we determined these data were 
reliable for the purposes of this report. Additional details regarding 
our methodology can be found in appendix I. 

We conducted this performance audit from July 2011 to June 2012 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Background: 

The Thrift Savings Plan: 

FERSA created TSP to provide options for retirement planning and 
encourage personal retirement saving among the federal workforce. Most 
federal workers are allowed to participate in TSP, which is available 
to federal and postal employees, including members of Congress and 
congressional employees and members of the uniformed services, and 
members of the judicial branch. TSP is structured to allow eligible 
federal employees to contribute a fixed percentage of their annual 
base pay or a flat amount, subject to Internal Revenue Service limits, 
into an individual tax-deferred account. Additionally, Federal 
Employees' Retirement System (FERS) participants are eligible for 
automatic 1-percent contributions and limited matching contributions 
from the employing federal agency. TSP provides federal (and in most 
cases, state) income tax deferral on contributions and their related 
earnings, similar to those offered by many private sector 401(k)-type 
pension plans.[Footnote 5] As is typical in defined contribution (DC) 
plans, TSP allows participants to manage their accounts and conduct a 
variety of transactions similar to those available to 401(k) 
participants, including reallocating contributions or account 
balances, borrowing from the account, making withdrawals, or 
purchasing annuities.[Footnote 6] 

Administration of TSP falls under the purview of the Board, an agency 
established by Congress under FERSA. The Board is composed of five 
members appointed by the President, with the advice and consent of the 
Senate. They are authorized to appoint the executive director who 
hires additional personnel, and ETAC--a 15-member council that 
provides advice to the Board and the executive director on the 
investment policies and administration of TSP.[Footnote 7] The Board 
is responsible for establishing policies for the investment and 
management of TSP, as well as administration of the plan. The 
executive director and Board staff are responsible for implementing 
the Board's policies and managing the day-to-day operations of TSP, 
prescribing regulations to administer FERSA, and other duties. The 
Board members and the executive director serve as plan 
fiduciaries.[Footnote 8] FERSA has other investment policy provisions, 
such as who can exercise voting rights associated with the ownership 
of stocks held by TSP.[Footnote 9] For example, the Board and the 
executive director may not exercise voting rights associated with the 
ownership of TSP securities. 

The Board has less discretion than private sector plan sponsors in 
setting investment policy because the investment options available to 
TSP participants are outlined in federal law, whereas private sector 
plan sponsors have greater discretion in choosing which investment 
options to offer participants.[Footnote 10] In addition, Congress must 
amend FERSA to approve a change in TSP investment options offered to 
participants. TSP's authorizing statute specifies the number and types 
of funds available to participants, and requires that some of these 
funds track indexes, which are broad, diversified market indicators. 
The Board may select the particular indices for the funds to follow as 
well as review the investment options and suggest additional funds. 
The Board has developed investment policies for each TSP fund. These 
policies, which the Board reaffirms quarterly, provide the rationale 
for selecting the fund's investments. Table 1 shows FERSA requirements 
and Board policies regarding each fund and its underlying index. 

Table 1: Investment Requirements for Existing TSP Funds: 

Fund: G Fund; 
FERSA investment requirements: Treasury securities specially issued to 
TSP with a maturity determined by the executive director that provide 
the generally higher interest rates of securities with a term of at 
least 4 years [5 U.S.C. § 8438(a)(4)]; 
Board investment policies: Short-term securities that mature in 1 to 4 
days. 

Fund: F Fund; 
FERSA investment requirements: Fixed-income securities [5 U.S.C. § 
8438(a)(3)]; 
Board investment policies: An index including bonds and asset-backed 
securities to track the Barclay's Capital U.S. Aggregate Bond Index. 

Fund: C Fund; 
FERSA investment requirements: A portfolio that tracks a broad index 
representing the U.S. stock market [5 U.S.C. § 8438(a)(1)]; 
Board investment policies: An index of stocks of large to medium-sized 
companies to track the Standard & Poor's 500 Index. 

Fund: S Fund; 
FERSA investment requirements: A portfolio that tracks a broad index 
representing U.S. stocks not included in the C Fund [5 U.S.C. § 
8438(a)(3)(B)]; 
Board investment policies: An index of stocks in small and medium-
sized companies not represented in the Standard & Poor's 500 Index to 
track the Dow Jones Total Stock Market Completion Index. 

Fund: I Fund; 
FERSA investment requirements: A portfolio that tracks a broad index 
representing international stock markets outside of the United States 
[5 U.S.C. § 8438(a)(5)]; 
Board investment policies: An index of the stock markets of the 
developed world outside of the United States and Canada to track the 
Morgan Stanley Capital International Europe, Australasia, and Far East 
Index. 

Source: GAO analysis of FERSA. 

[End of table] 

Members of Congress have introduced bills calling for new investment 
options to be added to TSP. In the past four sessions of Congress, a 
number of bills have been proposed to add investment options to TSP, 
including a corporate responsibility stock index fund, a precious 
metals investment fund, a real estate stock index fund, and a terror-
free international investment option. In addition, Congress passed the 
Federal Retirement Reform Act of 2009, which among other things, 
authorized TSP to offer a service that would enable participants to 
invest in mutual funds outside TSP, if the Board determined that such 
a mutual fund window was in the best interests of participants. 
[Footnote 11] The law stipulated that the Board had to ensure that any 
expenses charged for use of the mutual fund window would be borne 
solely by the participants who used it. The Board has not implemented 
the mutual fund window. According to TSP officials, both the Board and 
ETAC were similarly split on whether to include a mutual fund window 
and the Board tabled the discussion of the mutual fund window to 
address more immediate issues, such as adding a Roth TSP option. 
[Footnote 12] They also noted that while TSP has not moved forward 
with adding a mutual fund window, it may at some future point. 
[Footnote 13] 

FERSA also requires the Board to defray reasonable expenses of 
administering TSP.[Footnote 14] TSP's administrative expenses include 
management fees for each investment fund; the costs of operating and 
maintaining TSP's recordkeeping system; the cost of providing 
participant services; and the printing and mailing of notices, 
statements, and publications.[Footnote 15] These expenses are offset 
by (1) forfeitures of agency automatic (1 percent) contributions made 
to employees who participated in the FERS but left federal service 
before becoming vested,[Footnote 16] (2) other forfeitures, and (3) 
loan fees. Because these amounts are not sufficient to cover all of 
TSP's expenses, TSP participants share in the remainder of the costs. 
The cost to participants to invest in TSP is measured as an expense 
ratio of the total administrative expenses charged to a fund during a 
specific time period, divided by that fund's average balance for that 
specific time period. In 2011, expenses charged to each TSP account 
were approximately 25 cents per each $1,000 of investment, or 2.5 
basis points. TSP's expense ratio typically falls below the average 
expense ratio of other 401(k) type plans. 

Socially Responsible Investment: 

SRI--investment made on the basis of environmental, social, and 
corporate governance (ESG) criteria--is a global phenomenon and is 
growing in popularity in the United States. In 2006, the United 
Nations issued Principles for Responsible Investment that maintained a 
belief that ESG issues can affect the performance of investment 
portfolios and therefore must be given appropriate consideration by 
investors if they are to fulfill their fiduciary duty.[Footnote 17] By 
supporting the principles, institutional investors commit to better 
align investors with broader societal goals while acting in the best 
long-term interests of their beneficiaries. Specifically, signatories 
agreed to: 

* incorporate ESG issues into investment analysis and decision-making 
processes, 

* be active owners and incorporate ESG issues into their ownership 
policies and practices, 

* seek appropriate disclosure on ESG issues by the entities in which 
they invest, 

* promote acceptance and implementation of these principles within the 
investment industry to affect the performance of investment, 

* work together to enhance the effectiveness of the principles, and: 

* report on their activities and progress in implementing the 
principles. 

In 2012, there were more than 1,000 asset owners, investment managers, 
and professional service partners that had committed to these 
principles worldwide--136 of them in the United States, according to 
the United Nations' website. 

According to a 2010 report by US SIF[Footnote 18]--a leading SRI 
advocacy group--U.S.-based, open-end mutual funds comprise the largest 
share of funds that incorporate ESG factors in the United States with 
holdings of more than $300 billion. Other investment vehicles that 
incorporate ESG factors include exchange traded funds, variable 
annuity products, and alternative investment funds. As shown in figure 
1, the number of SRI mutual funds open to investors has grown steadily 
since 1990. 

Figure 1: Cumulative Growth in the Number of U.S. Open-end SRI Mutual 
Funds, 1952 through 2011: 

[Refer to PDF for image: vertical bar graph] 

Number of SRI mutual funds (all share classes): 

Year: 1952: 1; 
Year: 1971: 2; 
Year: 1972: 3; 
Year: 1973: 3; 
Year: 1974: 3; 
Year: 1975: 3; 
Year: 1976: 3; 
Year: 1977: 3; 
Year: 1978: 3; 
Year: 1979: 3; 
Year: 1980: 3; 
Year: 1981: 3; 
Year: 1982: 4; 
Year: 1983: 4; 
Year: 1984: 5; 
Year: 1985: 5; 
Year: 1986: 7; 
Year: 1987: 10; 
Year: 1988: 10; 
Year: 1989: 12; 
Year: 1990: 12; 
Year: 1991: 13; 
Year: 1992: 18; 
Year: 1993: 20; 
Year: 1994: 32; 
Year: 1995: 35; 
Year: 1996: 37; 
Year: 1997: 40; 
Year: 1998: 52; 
Year: 1999: 75; 
Year: 2000: 89; 
Year: 2001: 109; 
Year: 2002: 110; 
Year: 2003: 117; 
Year: 2004: 131; 
Year: 2005: 146; 
Year: 2006: 163; 
Year: 2007: 190; 
Year: 2008: 223; 
Year: 2009: 238; 
Year: 2010: 260; 
Year: 2011: 266. 

Source: GAO analysis of inception date data for SRI mutual funds 
active as of December 2011 from Morningstar, Inc. and US SIF. 

[End of figure] 

According to US SIF, there are three principal components of SRI: 

* Investment screening. Investment screening is a practice of 
evaluating investment portfolios or mutual funds based on ESG 
criteria. Screening may involve including only strong performers, 
avoiding poor performers, or otherwise incorporating ESG factors into 
the process of investment analysis and management. Some responsible 
investors may avoid investment in companies whose products and 
business practices are harmful to individuals, communities, or the 
environment. Others may apply SRI screens to invest in companies that 
are leaders in adopting clean technologies and exceptional social and 
governance practices. 

* Shareholder advocacy. Shareholder advocacy involves engaging 
companies directly on issues of concern through shareholder 
resolutions or proxy voting. Shareholder advocacy frequently involves 
the filing of shareholder resolutions to improve business practices. 
The resolutions are then voted on by all owners of a corporation. For 
example, shareholders can use resolutions to urge a company to improve 
its sustainability practices, such as by reducing its carbon 
emissions, or by improving its supply chain to ensure that labor laws 
are fully enforced. Similarly, proxy voting is the primary means by 
which shareholders are able to direct company management to act in a 
socially responsible manner. As partial owners of companies, 
shareholders have the right to weigh in on important issues through 
the process of proxy voting. 

* Community investing. Community investing directs capital from 
investors and lenders to communities that are underserved by 
traditional financial services institutions. Community investing 
provides access to credit, equity, capital, and basic banking products 
that these communities would otherwise lack. 

According to experts, investors pursue SRI for a variety of reasons. 
Some investors may invest solely in accordance with their values 
without considering financial implications. Other investors may pursue 
SRI for purely financial motives and seek out well managed companies 
that take steps to manage their ESG risks in the belief that these 
companies will outperform their competitors in the long run. SRI 
mutual funds offer a broad range of investment screens, including 
negative screens, which exclude industry sectors associated with 
certain products or processes; restricted screens, which set a 
threshold for investment in companies associated with certain products 
or processes; and positive screens, which include industry sectors 
associated with certain products, processes, or values, or invest in 
"best-in-class" companies that demonstrate the strongest record of 
incorporating ESG criteria into their business models. Figure 2 
provides an overview of investment screens applied by current SRI 
mutual funds in the United States. 

Figure 2: Investment Screens Applied by SRI Mutual Funds: 

[Refer to PDF for image: horizontal bar graph] 

Number of SRI mutual funds (all classes): 

Screening type: Environmental: 

Climate/"clean" tech: 
No investment: 4; 
Restricted investment: 0; 
Positive investment: 131. 

Pollution/Toxics: 
No investment: 0; 
Restricted investment: 0; 
Positive investment: 123. 

Nuclear power:
No investment: 17; 
Restricted investment: 53; 
Positive investment: 0. 

Other environmental: 
No investment: 6; 
Restricted investment: 9; 
Positive investment: 178. 

Screening type: Social: 

Human rights: 
No investment: 45; 
Restricted investment: 9; 
Positive investment: 91. 

Labor relations: 
No investment: 4; 
Restricted investment: 9; 
Positive investment: 127. 

Diversity/equal employment: 
No investment: 1; 
Restricted investment: 3; 
Positive investment: 134. 

Community development: 
No investment: 0; 
Restricted investment: 0; 
Positive investment: 132. 

Indigenous rights: 
No investment: 0; 
Restricted investment: 6; 
Positive investment: 52. 

Alternative lifestyles: 
No investment: 18; 
Restricted investment: 0; 
Positive investment: 0. 

Sudan: 
No investment: 8; 
Restricted investment: 0; 
Positive investment: 0. 

Screening type: Governance: 

Board issues: 
No investment: 0; 
Restricted investment: 1; 
Positive investment: 100. 

Executive pay: 
No investment: 0; 
Restricted investment: 0; 
Positive investment: 83. 

Philanthropy/volunteerism: 
No investment: 0; 
Restricted investment: 0; 
Positive investment: 22. 

Screening type: Product/Process: 

Tobacco: 
No investment: 100; 
Restricted investment: 102; 
Positive investment: 0. 

Alcohol: 
No investment: 85; 
Restricted investment: 101; 
Positive investment: 0. 

Gambling: 
No investment: 100; 
Restricted investment: 85; 
Positive investment: 0. 

Defense/weapons: 
No investment: 100; 
Restricted investment: 86; 
Positive investment: 0. 

Animal testing: 
No investment: 94; 
Restricted investment: 3; 
Positive investment: 0. 

Adult entertainment: 
No investment: 15; 
Restricted investment: 71; 
Positive investment: 0. 

Abortion/contraception: 
No investment: 4; 
Restricted investment: 65; 
Positive investment: 0. 

Financial services: 
No investment: 0; 
Restricted investment: 4; 
Positive investment: 0. 

Pork products: 
No investment: 0; 
Restricted investment: 4; 
Positive investment: 0. 

Health care: 
No investment: 1; 
Restricted investment: 0; 
Positive investment: 0. 

Source: GAO analysis of inception data for the 266 SRI mutual funds 
active as of December 2011 from Morningstar, Inc and US SIF. 

[End of figure] 

Officials Identified Several Challenges to SRI Adoption and Said the 
Long-term Economic Benefits of SRI Were Unknown: 

Challenges: 

Officials at TSP and the other public retirement plans that had 
considered adding an SRI option associated a number of common 
challenges with the implementation of SRI. While none of the plan 
officials that we contacted had plans that were identical to TSP in 
terms of its federal scope or participant demographics, many of them 
shared similar challenges and concerns with TSP.[Footnote 19] As shown 
in figure 3, participant demand, SRI screening criteria, and costs 
were the most common challenges identified by public retirement plans. 

Figure 3: Number of Public Retirement Plans Identifying Challenges 
Associated with SRI Adoption Similar to Ones Identified by TSP 
Officials: 

[Refer to PDF for image: illustrated table] 

Challenge: Demand; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 5; 
Implemented SRI (9 plans): 4. 

Challenge: Screening criteria; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 6; 
Implemented SRI (9 plans): 3. 

Challenge: Costs; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 4; 
Implemented SRI (9 plans): 3. 

Challenge: Performance; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 3; 
Implemented SRI (9 plans): 2. 

Challenge: Political issues; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 2; 
Implemented SRI (9 plans): 2. 

Challenge: Fiduciary issues: 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 4; 
Implemented SRI (9 plans): 0; 

Challenge: Investment overlap; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 0; 
Implemented SRI (9 plans): 1. 

Challenge: Peer practice; 
Number of plans citing challenge: 
Did not implement SRI (6 plans): 4; 
Implemented SRI (9 plans): 0. 

Source: GAO analysis of interviews with public retirement plan 
officials. 

[End of figure] 

Participant Demand: 

TSP and most other public plan officials we contacted identified low 
participant demand for SRI as a challenge to adopting SRI. TSP 
officials told us that based on the results of their participant 
surveys and the experiences of ETAC there was little demand for an SRI 
fund among TSP participants. Specifically, they noted that the results 
of periodic participant surveys have consistently indicated that there 
was no overwhelming demand for any new investment options, including 
an SRI option.[Footnote 20] In addition, ETAC members told us that 
they were unaware of demand for SRI among TSP participants. They said 
that they would respond if demand ever presented itself. While 
consultants and fund managers that we contacted reported a growing 
demand for SRI in the United States, public plan officials that we 
spoke with generally reported low participant interest in SRI 
adoption. Officials at several plans noted that continued pressure and 
repeated demands from small vocal groups of participants in support of 
SRI had been a principal driver in the plans' decision to have an SRI 
option. However, officials at several of these plans said that, while 
the SRI option did attract a small percentage of participants, overall 
participation in the SRI funds ranged from less than 0.5 percent (in 
one plan with 20 investment options) to about 10 percent (in a plan 
that offered 9 investment options).[Footnote 21] 

Selection of SRI criteria: 

TSP and most other public plan officials we contacted identified the 
difficulty of finding broadly acceptable SRI criteria as a distinct 
challenge to adopting SRI. According to TSP officials, different 
interpretations of what social criteria to apply to an SRI fund could 
lead to the need to develop multiple funds to satisfy participants. 
Officials also noted that it would be hard to reach agreement on what 
values an SRI fund should endorse. Moreover, officials at most of the 
other plans we contacted said that the lack of a common definition of 
SRI and the selection of SRI criteria was challenging. For example, 
officials at one plan noted that social issues were difficult to 
incorporate into an investment approach because, while some basic 
social issues, such as child labor, imprisonment, and forced slavery, 
were generally acceptable screens, reaching broad consensus on other 
issues, such as labor laws, workers' rights, weapons, guns, and 
tobacco, was more difficult. An official at another plan noted that it 
was incumbent upon participants to tell them what social policy they 
wished to pursue. Officials at the plans we contacted that considered 
selection of screening criteria to be a challenge overcame this 
challenge by either using an off-the shelf SRI fund, or relying on the 
expertise and experience of the SRI fund managers, or educating 
participants on why fund managers selected the investments they did. 

Costs: 

TSP and other public plan officials we contacted had varied opinions 
on the degree to which the costs associated with the creation and 
administration of an SRI index fund presented a challenge to adopting 
SRI. According to TSP officials, the costs to create a new index fund 
would be considerable. In addition, they said an SRI index fund would 
cost more because it requires additional screening and monitoring. 
Under TSP's current cost structure, any costs associated with a new 
SRI index fund would be borne by all participants whether or not they 
chose to invest in the SRI index fund.[Footnote 22] Other public plan 
officials we contacted had varied opinions on the degree to which 
these costs presented a challenge. While there would be certain 
upfront costs associated with adding an SRI fund, which could include 
member communication and manager selection, officials at several plans 
said that adding a new fund to its existing portfolio would not 
adversely affect administrative costs. According to some investment 
managers we contacted, the key factors affecting cost of any fund are 
(1) its asset size--the larger the asset base, the better the 
economies of scale and the lower the overall cost ratio--and (2) 
whether the fund's investment strategy requires active management or 
passively tracking of a market index. 

Fiduciary Issues: 

While TSP and some public plan officials we contacted asserted that 
their role as fiduciary was a challenge in that it precluded the 
adoption of SRI, officials at other public plans with an SRI option 
said there were no fiduciary concerns surrounding the inclusion of an 
SRI option in a DC plan. According to a 1990 memorandum sent from the 
TSP executive director to the Board, Congress considered and rejected 
the concept of social investment when creating TSP. The memorandum 
noted that the strict fiduciary provisions of the law, which require 
the Board to discharge its responsibilities solely in the interest of 
participants, excluded the possibility of social investing, and that 
any authorization outside the realm of interest of all participants 
would be inconsistent with the notion of employee ownership of TSP 
assets. Officials at all of the public plans that had not implemented 
an SRI option considered fiduciary issues a challenge to adopting SRI, 
while officials at other plans did not. For example, an official at 
one plan with an SRI option stated that fiduciary duty was not a 
challenge when adding an SRI fund to the investment options to a DC 
plan because participants have individual account ownership, are free 
to choose how they invest, and must assume responsibility for any 
risks associated with the underlying investments. One plan official 
noted that the fiduciary responsibility of a DC plan extends to 
exercising due diligence in the selection of a fund manager, providing 
appropriate participant communications about the fund, offering enough 
investment options, and acting in the best interest of the majority of 
participants. 

Concerns about Political Interference: 

TSP and some public plan officials that we contacted asserted that 
investment decisions made on any basis other than the economic welfare 
of participants could present a challenge in that it would expose the 
plan to potential political interference. In its 2006 investment 
option review, a consulting firm hired by TSP eliminated SRI from 
consideration in part on the grounds that identifying screening 
criteria that all could agree to would be difficult to find and likely 
draw attention from opposing parties of interest.[Footnote 23] 
According to the 1990 memorandum from the TSP executive director, the 
laws that established the current TSP funds prevent the political 
manipulation of TSP funds, and officials told us that TSP has taken 
steps in the past to avoid political interference. Officials at the 
public plans we contacted had different views on the extent to which 
political interference was a challenge. For example, officials at some 
public plans that did not implement SRI identified political 
interference as one of the reasons they chose not to do so. On the 
other hand, officials at other public plans that had implemented SRI 
said that political interference was not a challenge. For example, 
officials at one public plan noted that the state's legislative 
mandate to maximize returns and improve levels of risk prevented 
political interference. An official at another public plan that 
adopted SRI told us that although they had anticipated political 
interference by state officials following their decision to divest 
from alcohol or tobacco companies, it had not materialized. 

SRI Performance: 

Officials at TSP and some other public plans identified SRI fund 
performance as a challenge to adopting an SRI fund. According to TSP 
officials, participants who allocated assets to an SRI fund instead of 
a standard fund that included all relevant companies would narrow the 
number of companies in which they were indirectly investing, thereby 
limiting their exposure to the performance of the broader, more 
diversified market. While officials at some public plans that we 
contacted believed that SRI funds had lower performance than other 
funds, other officials had mixed views on whether the performance of 
SRI funds was any more challenging than the performance of non-SRI 
funds. Officials at several plans, which had considered but not 
implemented SRI, cited SRI performance as a reason for not 
incorporating SRI in their plans. Officials at one plan said they 
would reconsider offering an SRI fund if it demonstrated better long-
term performance than non-SRI funds. However, officials at several 
other plans that implemented SRI told us that the SRI fund produced 
comparable and sometimes better returns than other funds in their 
portfolio. Officials at one plan said the plan would terminate its 
working relationship with an external fund manager if its SRI 
investments did not perform as well as other funds. 

Peer Practice: 

While TSP officials considered the lack of peer implementation of SRI 
as a challenge to adopting an SRI fund, officials at other public 
plans we contacted said that it was not a challenge. As part of its 
investment options review in 2006, a consulting firm advised TSP that 
SRI funds were not a common practice among TSP's peers and identified 
this criterion as a reason for eliminating SRI from further 
consideration. According to TSP officials, the fact that similar plans 
had not adopted SRI was a challenge in that TSP had no precedent to 
follow. We found a number plans similar in asset size and membership 
to TSP that applied SRI principles through investment screening. 
Officials at several plans we contacted said that peer implementation 
of SRI did not factor in their decision to incorporate SRI into their 
investment strategy. 

Investment Overlap: 

Officials at most of the public plans we contacted had no restrictions 
regarding investment overlap between funds and thus did not view such 
overlap as a challenge to adopting SRI. According to TSP officials, 
the Board is permitted to suggest legislation to address any gaps in 
investment options as long as there is no evident overlap. In the 
past, for example, TSP proposed legislation authorizing the addition 
of the S Fund and the I Fund to provide participants with options for 
greater diversification of investments in the small capitalization and 
international markets. According to TSP officials, each of the current 
funds tracks different companies in different segments of the overall 
financial market without overlap, helping to reduce the risk of 
incurring large losses on a broader portfolio. Officials at other 
public plans, which did not face the same restrictions as TSP, said 
that overlap was not a consideration, and that certain amount of 
overlap with existing investments was both expected and accepted. Some 
officials noted that the purpose of SRI was to select companies that 
met certain criteria and provided an alternative investment choice. 

Benefits: 

Officials at some of the nine public plans we contacted that offered 
an SRI option cited some short-term benefits associated with SRI but 
said that the long-term benefits were unknown. For example, officials 
at several plans noted that the greatest benefit of having an SRI 
option is giving participants broader investment choice and an 
opportunity to make a statement in the way they invest. Officials at 
other plans said that having an SRI option could serve as a recruiting 
tool for the plan in that it encouraged more eligible employees to 
join the plan. Regarding the long-term benefits of SRI, officials at 
two of the public plans stated that it was still too early to judge 
the benefit of SRI. As one plan official noted, responsible investment 
involves making investment decisions that are important to the long-
term value and profitability of a company over time. 

Adding an SRI Index Fund Would Not Have Improved Past TSP Portfolio 
Performance in Most Allocation Scenarios: 

When compared to the past performance of the TSP stock portfolio (the 
C, S, and I Funds), the addition of a hypothetical SRI index fund 
tracking the best-performing U.S.-based SRI stock index would not have 
both increased returns and lowered volatility in any allocation 
scenario we tested. Specifically, over the last 20 years, if TSP had 
included such an SRI index fund (SRI Fund) in its existing stock 
portfolio,[Footnote 24] it could have resulted in (1) lower returns 
and lower volatility, (2) lower returns and higher volatility, or (3) 
higher returns and higher volatility, based on our analysis of evenly 
distributed portfolio allocations containing the SRI Fund against the 
TSP stock portfolio alone (a C, S, and I Funds combination).[Footnote 
25] For example, as shown in figure 4, adding the SRI Fund to the 
existing TSP stock funds (an SRI, C, S, and I Funds combination) would 
have resulted in lower returns and lower volatility; substituting the 
SRI Fund for the C Fund (an SRI, S, and I Funds combination) would 
have resulted in lower returns and higher volatility; and substituting 
the SRI Fund for the I Fund (an SRI, C, and S Funds combination) would 
have resulted in higher returns and higher volatility.[Footnote 26] 
Because this analysis is strictly based on past performance, this 
result does not guarantee or imply that the addition of an SRI index 
would have the same effect on future TSP stock fund portfolio 
performance. 

Figure 4: Effect of Adding a Hypothetical TSP SRI Index Fund on Past 
TSP Stock Portfolio Performance, 1992 to 2011: 

[Refer to PDF for image: plotted point graph] 

Horizontal matrix is lower returns to higher returns (compound rates 
of return); 
Vertical matrix is lower volatility to higher volatility (standard 
deviation). 

At center of matrix: 
C, S, I (existing TSP stock funds). 

Quadrants and points depicted: 

More risk and lower returns: 
SRI only; 
SRI, S, I. 

More risk and higher returns: 
SRI, S; 
SRI, C, S. 

Less risk and lower returns: 
SRI, C; 
SRI, C, S, I; 
SRI, I; 
SRI, C, I. 

Less risk and lower returns: 
None. 

Source: GAO analysis of annual rates of total return based on monthly 
total return data from Morningstar, Inc. 

Notes: 

1. We used a time-weighted basis for our analysis and rebalanced 
portfolios annually to maintain the evenly distributed allocations. A 
time-weighted basis gives equal weight to each unit of time; thus, the 
annual rate of return in 1992 gets just as much weight in the analysis 
as the annual rate of return in 2011. We used a time-weighted analysis 
in order to focus on investment performance itself, rather than on the 
particular economic consequences in the time period under study. For a 
TSP participant, the overall compound rate of return would be affected 
by interim cash flow into and out of the plan. For example, for a TSP 
participant who made regular contributions to the plan during the 1992 
to 2011 period, the overall rate of return would be more influenced by 
particular performance in the later years, when more contributions are 
at stake, than in the earlier years. 

2. In this figure, returns represent annualized compound return (i.e., 
geometric average annual return), while volatility represents standard 
deviation of annual return. 

[End of figure] 

Overall, portfolio performance is directly tied to the individual fund 
performance, which varied by time period. A comparison of the 
underlying indices of these four funds shows that, while the SRI Fund 
had higher cumulative returns than the I Fund over the last 20 years, 
it had lower cumulative returns than all three of the TSP funds over 
the last 10 years. Figure 5 shows the funds' annual and cumulative 
returns and highlights their performance during market cycles. 

Figure 5: Annual and Cumulative Returns of the Indices Underlying the 
C, S, I, and SRI Funds, 1992 to 2011: 

[Refer to PDF for image: multiple line graph] 

Annual returns: 

Year: 1992; 
Common stock: 7.6%; 
Small capitalization: 11.7%; 
International capitalization: -11.8%; 
Socially responsible investment: 10.1%. 

Year: 1993; 
Common stock: 10.1%; 
Small capitalization: 14.5%; 
International capitalization: 32.9%; 
Socially responsible investment: 6.4%. 

Year: 1994; 
Common stock: 1.3%; 
Small capitalization: -2.6%; 
International capitalization: 8.1%; 
Socially responsible investment: 0.8%. 

Year: 1995; 
Common stock: 37.6%; 
Small capitalization: 33.6%; 
International capitalization: 11.6%; 
Socially responsible investment: 35.1%. 

Year: 1996; 
Common stock: 23.0%; 
Small capitalization: 17.1%; 
International capitalization: 6.4%; 
Socially responsible investment: 21.4%. 

Year: 1997; 
Common stock: 33.4%; 
Small capitalization: 25.5%; 
International capitalization: 2.1%; 
Socially responsible investment: 36.1%. 

Year: 1998; 
Common stock: 28.6%; 
Small capitalization: 8.7%; 
International capitalization: 20.3%; 
Socially responsible investment: 30.4%. 

Year: 1999; 
Common stock: 21.0%; 
Small capitalization: 35.5%; 
International capitalization: 27.3%; 
Socially responsible investment: 23.1%. 

Year: 2000; 
Common stock: -9.1%; 
Small capitalization: -15.7%; 
International capitalization: -14.0%; 
Socially responsible investment: -15.0%. 

2001: recession period. 

Year: 2001; 
Common stock: -11.9%; 
Small capitalization: -9.4%; 
International capitalization: -21.2%; 
Socially responsible investment: -13.0%. 

Year: 2002; 
Common stock: -22.1%; 
Small capitalization: -17.8%; 
International capitalization: -15.7%; 
Socially responsible investment: -21.2%. 

Year: 2003; 
Common stock: 28.7%; 
Small capitalization: 44.0%; 
International capitalization: 39.2%; 
Socially responsible investment: 26.4%. 

Year: 2004; 
Common stock: 10.9%; 
Small capitalization: 18.0%; 
International capitalization: 20.7%; 
Socially responsible investment: 8.7%. 

Year: 2005; 
Common stock: 4.9%; 
Small capitalization: 10.0%; 
International capitalization: 14.0%; 
Socially responsible investment: 1.4%. 

Year: 2006; 
Common stock: 15.8%; 
Small capitalization: 15.3%; 
International capitalization: 26.9%; 
Socially responsible investment: 11.3%. 

2007-2009: recession period. 

Year: 2007; 
Common stock: 5.5%; 
Small capitalization: 5.4%; 
International capitalization: 11.6%; 
Socially responsible investment: 1.9%. 

Year: 2008; 
Common stock: -37.0%; 
Small capitalization: -39.0%; 
International capitalization: -43.1%; 
Socially responsible investment: -36.3%. 

Year: 2009; 
Common stock: 26.5%; 
Small capitalization: 37.4%; 
International capitalization: 32.5%; 
Socially responsible investment: 28.9%. 

Year: 2010; 
Common stock: 15.1%; 
Small capitalization: 28.6%; 
International capitalization: 8.2%; 
Socially responsible investment: 9.9%. 

Year: 2011; 
Common stock: 2.1%; 
Small capitalization: -3.8%; 
International capitalization: -11.7%; 
Socially responsible investment: -0.3%. 

Socially responsible investment: 
Cumulative returns: 
20 year: 250%; 
10 year: 12%; 
Recession (March-November 2001): -7%; 
Recession (December 2007-June 2009): -35%. 

Common stock: 
Cumulative returns: 
20 year: 350%; 
10 year: 33%; 
Recession (March-November 2001): -7%; 
Recession (December 2007-June 2009): -35%. 

Small capitalization: 
Cumulative returns: 
20 year: 433%; 
10 year: 94%; 
Recession (March-November 2001): -7%; 
Recession (December 2007-June 2009): -34%. 

International capitalization: 
Cumulative returns: 
20 year: 162%; 
10 year: 65%; 
Recession (March-November 2001): -15%; 
Recession (December 2007-June 2009): -40%. 

Source: GAO analysis of annual rates of total return based on monthly 
total return data from Morningstar, Inc. 

[End of figure] 

The managers of the SRI index explained the difference in the index's 
performance over the last 20 years in comparison with the Standard & 
Poor's 500 Index (the C Fund index) was a result of having different 
sector weightings than the overall market to align with the fund's SRI 
strategy. For example, they told us that, in the late 1990s, the index 
was relatively overweighted in technology, consumer, and finance 
stocks and underweighted in energy and utilities, resulting in higher 
performance in the "dot com" boom of the late 1990s and lower 
performance in the 2001 recession. Moreover, the SRI index also 
excludes companies involved in the production of military weapons, 
which may have contributed to lower returns over the past decade while 
the country has been at war. 

In addition to providing less return overall than the C Fund over the 
20-year period, the inclusion of this SRI Fund would have resulted in 
overlap with the C Fund and not have provided a substantial 
opportunity for additional portfolio diversification.[Footnote 27] By 
law, holdings in TSP stock funds may not overlap. Fifty-seven percent 
of the companies included in the SRI Fund index, which includes large, 
mid, and small capitalization stocks, overlap with companies included 
in the C Fund index.[Footnote 28] In part, as a result of this 
overlap, the SRI Fund and the C Fund are highly correlated in their 
returns, and thus adding this SRI Fund would not provide a substantial 
opportunity for additional portfolio diversification. Portfolio 
diversification aims to reduce risk by investing in various financial 
instruments and markets so that market events will not affect all 
assets in the same way. Diversification opportunities exist if 
investments have independent price movement, and therefore, 
independent returns. The price movement between these two funds over 
the last 20 years was 1.94 percent independent, suggesting that the 
same external causes affected their returns to nearly the same degree. 
[Footnote 29] By contrast, over the same time period, the independence 
in price movement between the S Fund and C Fund was 17.27 percent, and 
between the I Fund and C Fund was 42.19 percent. 

SRI Mutual Fund Performance Varied by Asset Class, but Had Similar 
Costs to Non-SRI Mutual Funds: 

After Controlling for Fund Size and Strategy, SRI Bond Mutual Funds 
and SRI Stock Mutual Funds Outperformed Their Non-SRI Counterparts: 

Looking more broadly at SRI mutual funds, the most common form of SRI 
in the United States, we found that the comparative performance of SRI 
and non-SRI mutual funds over the last 15 years varied by asset class. 
While TSP participants cannot currently invest in mutual funds through 
TSP, the Board is authorized to offer a mutual fund window if it 
determines that it is in the best interests of participants. 
Specifically, our analysis of institutional-grade mutual funds 
[Footnote 30] over the last 5, 10, and 15 years (dating back from 
December 2011) found that SRI bond mutual funds had better risk-
adjusted performance than their non-SRI counterparts. In contrast, SRI 
stock funds and SRI balanced funds--which hold bonds and stocks--had 
worse risk-adjusted performance than their non-SRI counterparts over 
these time periods.[Footnote 31] Because this analysis is strictly 
based on past performance, these results do not guarantee or imply 
that these asset classes would perform similarly in the future. 

After controlling for fund size and investment strategies (other than 
SRI approaches), we found that the performance gap between the SRI and 
non-SRI mutual funds narrowed significantly for stock funds but not 
for balanced funds. Moreover, our regression estimates showed that SRI 
stock mutual funds performed better than their non-SRI stock 
counterparts in the 5-and 15-year timeframes, after controlling for 
differences in asset size, share class, and investment strategies. 
[Footnote 32] (See appendix I for additional information on the 
regression analyses.) 

SRI and Non-SRI Mutual Funds Had Similar Costs: 

In fiscal year 2010, the costs of SRI institutional grade mutual funds 
were similar to their non-SRI counterparts. It is important to note 
that our cost analysis included only the most recent year of data 
available (fiscal year 2010) for three share classes of institutional 
grade mutual funds, and it did not look at all SRI product types such 
as variable annuities or exchange traded funds, which may have had 
higher costs.[Footnote 33] In addition, fiscal year 2010 cost data are 
not indicative of past or future costs. As shown in figure 7, there 
was considerable overlap in the costs associated with these funds, as 
measured by their annual net expense ratio--the actual percentage of 
assets deducted each fiscal year for fund expenses.[Footnote 34] 

Figure 6: Comparison of Annual Net Expense Ratios of SRI and Non-SRI 
Mutual Funds: 

[Refer to PDF for image: illustration] 

Annual net expense ratios are depicted: 

SRI: 
Minimum: 
Average: 
Maximum[A]: 
90% cost range (151 funds): 

Non-SRI: 
Minimum: 
Average: 
Maximum[A]: 
90% cost range (6,557 funds): 

Source: GAO analysis of Morningstar, Inc. annual net expenses ratio 
data (front-load, no-load, and institutional share class mutual funds 
only). 

[A] The non-SRI maximum annual net expense ratio was 7.93 percent. 

[End of figure] 

While non-SRI mutual funds had a broader range of costs than SRI 
mutual funds, the vast majority of SRI and non-SRI funds reported 
expense ratios from 0.12 to 1.81 percent. On average, the reported 
expense ratios for SRI mutual funds were 0.2 percentage points higher 
than non-SRI mutual funds.[Footnote 35] When asset size and investment 
strategy were taken into account, SRI mutual fund cost ratios were 
estimated to be only 0.06 percentage points higher than non-SRI mutual 
fund cost ratios.[Footnote 36] For additional details on our 
regression analysis on cost ratios, see appendix I. 

Concluding Observations: 

Adoption of an SRI index fund would present challenges for TSP. 
Currently, the law limits the types of funds that TSP can offer, 
prohibits overlap among existing funds, and charges TSP to keep its 
costs low. First, TSP would have difficulty finding an SRI index fund 
that did not overlap with the existing TSP funds, limiting 
opportunities for additional portfolio diversification. However, 
officials at other DC plans, which do not face the same restrictions 
as TSP, said that a certain amount of overlap with SRI and other 
investment options was acceptable and the purpose of SRI was to 
provide an alternative investment choice. Second, TSP would have 
difficulty selecting SRI screening criteria that all participants and 
the Congress would find acceptable. While challenging, a number of 
plans have a long history of SRI in their plans. Finally, under TSP's 
current structure, the costs of adding a new fund would be distributed 
among all participants regardless of whether they participated in that 
fund. We note that the Board has the authority to open a mutual fund 
window for participants to invest in mutual funds managed outside TSP. 
If the Board decides to act on this authority and allow the mutual 
fund window, participants seeking other forms of investment, including 
SRI, could invest in mutual funds and would bear the costs associated 
with this investment. 

Agency Comments: 

We provided a copy of this draft report to the Federal Retirement 
Thrift Investment Board, the Department of Labor, and the Department 
of the Treasury for review and comment. None of the agencies provided 
formal comments. The Department of Labor provided technical comments, 
which we incorporated in the report, as appropriate. 

As agreed with your office, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 30 days 
from its issue date. At that time, we will send copies of this report 
to relevant congressional committees and other interested parties. In 
addition, this report will be available at no charge on GAO's website 
at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions about this report, please 
contact me at (202) 512-7215 or jeszeckc@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff making key contributions to 
this report is listed in appendix IV. 

Sincerely yours, 

Signed by: 

Charles A. Jeszeck: 
Director: 
Education, Workforce, and Income Security Issues: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

To determine the challenges associated with socially responsible 
investment (SRI), we reviewed relevant federal laws, regulations, and 
literature. For example, we reviewed the Federal Employees' Retirement 
System Act of 1986, the Federal Retirement Reform Act of 2009, and the 
2006 United Nations' Principles for Responsible Investment. We also 
interviewed officials from the Thrift Savings Plan (TSP), the Employee 
Thrift Advisory Council, investment management and consultant firms, 
and 15 selected public pension plans. Our nonrepresentative sample of 
pension plans included 9 domestic defined contribution (DC) and 
defined benefit (DB) plans that incorporated SRI, and 6 plans that 
considered but did not adopt an SRI component. To identify our sample, 
we contacted plans that were signatories of the United Nations' 
Principles for Responsible Investment and employed a snowball sampling 
technique based on recommendations of interviewees. We analyzed 
interview responses of pension plan officials and other SRI experts on 
the challenges and benefits associated with SRI, and how these 
experiences might affect TSP. 

To determine how the addition of an SRI index fund to a TSP stock 
portfolio would have affected past TSP stock portfolio performance, we 
identified the best performing U.S.-based SRI index and assessed its 
potential impact on the TSP stock portfolio based on historical 
performance data of the three TSP stock fund underlying indices. 
[Footnote 37] To identify the best performing U.S.-based SRI stock 
index (SRI Fund) we (1) identified all U.S.-based SRI stock indices 
with at least a 10-year history, and (2) selected the index with the 
best 10-year Sharpe ratio (dating back from December 2011).[Footnote 
38] To determine how the SRI Fund would have affected TSP stock 
portfolio performance from 1992 to 2011, we analyzed monthly total 
return data for the SRI Fund and the underlying indices of the three 
TSP stock funds provided by Morningstar, Inc.--a leading independent 
financial market research firm. We used these data to analyze changes 
in annual returns and volatility, in a manner similar to past analysis 
conducted by TSP when considering whether to add funds to the TSP 
portfolio. An important element of any performance statistic is the 
unit of time measurement. Our analysis measures returns on an annual 
basis, and measures risk based on the variation in year-to-year 
returns. Using a different unit of time, such as a month or even a 
multi-year period, could give a different picture of the risk/reward 
tradeoff. We calculated the compound rates of return and standard 
deviation[Footnote 39] based on annual rates of return from 1992 to 
2011 for an annually rebalanced, evenly distributed portfolio of the 
three existing TSP stock fund indices (a distribution of 33 percent, 
33 percent, and 33 percent). We then calculated the change in compound 
rates of return and standard deviation of annual returns for the 
following evenly distributed portfolios: 

* a four-way combination (25 percent, 25 percent, 25 percent, and 25 
percent) of the SRI Fund and the three TSP stock funds indices, 

* all of the three-way combinations (33 percent, 33 percent, and 33 
percent) of the SRI Fund with two of the TSP stock fund indices, 

* all two-way combinations (50 percent and 50 percent) of the SRI Fund 
with one of the TSP stock fund indices, and: 

* the SRI Fund alone (100 percent). 

Another decision in any performance assessment is whether to do the 
analysis on a time-weighted or a dollar-weighted basis. A time-
weighted basis gives equal weight to each unit of time; thus, the 
annual rate of return in 1992 gets just as much weight in the analysis 
as the annual rate of return in 2011. A dollar-weighted basis gives 
greater weight to the periods when more money is at stake. For 
example, for a TSP participant who made regular contributions to the 
plan during the 1992 to 2011 period, the overall rate of return would 
be more influenced by particular performance in the later years, when 
more contributions are at stake, than in the earlier years. We used a 
time-weighted basis for our analysis, in order to focus on investment 
performance itself, rather than on the particular economic 
consequences in the time period under study. 

To further assess the performance of the SRI Fund, we compared annual 
rates of return and compound cumulative rates of return for the three 
TSP stock fund indices over various time periods. Specifically, we 
reviewed performance over the 20-year period (1992 to 2011), the 10-
year period (2002 to 2011), and periods of market weakness. Because 
this analysis is strictly based on past performance, this result does 
not guarantee or imply that the addition of an SRI index would have 
the same effect on future TSP stock fund portfolio performance. In 
addition, we analyzed the overlap of holdings of the SRI Fund and the 
C Fund as of April 2012. To analyze the diversification potential of 
the SRI Fund for the TSP stock portfolio, we analyzed the correlation 
coefficient, common variance, and independence of price movement 
between the SRI Fund and the C Fund over the last 20 years.[Footnote 
40] 

To determine how the performance and cost of SRI mutual funds compare 
with those of non-SRI mutual funds, we compared performance over the 
past 15 years (1997 to 2011)--the longest time period for which data 
were available--and costs as of fiscal year 2010 provided by 
Morningstar. To identify the universe of SRI mutual funds, we included 
mutual funds from Morningstar considered to be SRI mutual funds based 
on ethical screen employed and data on SRI mutual funds maintained by 
US SIF.[Footnote 41] To analyze performance and cost of SRI and non-
SRI mutual funds active as of December 2011, we focused our analysis 
exclusively on three institutional grade share classes--institutional, 
front-load and no-load--of U.S. domiciled open-end mutual funds, which 
experts identified as the most common form of SRI funds. We did not 
examine other forms of SRI, such as exchange traded funds, hedge 
funds, or variable annuities. Because this analysis is strictly based 
on past performance, these results do not guarantee or imply that 
these asset classes would perform similarly in the future. Performance 
statistics include measures of risk-adjusted returns over 5-, 10-, and 
15-year time periods dating back from December 2011. Some mutual funds 
had more recent inception dates, thus limiting the number of funds in 
longer-term performance comparisons. Risk-adjusted return statistics 
include the Sharpe and Sortino ratios. Cost measures include fiscal 
year 2010 annual report net-expense ratios.[Footnote 42] 

To investigate why SRI and non-SRI mutual funds differed in 
performance, we ran regressions with and without controls for fund 
size, share class, and investment strategy not inherently related to 
SRI. We used the risk-adjusted performance measures, Sharpe and 
Sortino ratios, as the dependent variables. Table 2 summarizes the 
results of 24 regressions for U.S. stock funds. The numbers in the 
columns labeled Year: Outcome Variable 1Year: and Year: Outcome 
Variable 2Year: are coefficient estimates on a flag indicating that a 
fund was non-SRI.[Footnote 43] 

Table 2: Regression Coefficients on Non-SRI Indicator: U.S. Stock 
Funds, Institutional, Front-load, and No-load Share Classes: 

Time frame and control variables: 5-year, without control variables; 
Outcome variable 1, Sharpe ratio: 0.014; 
Outcome variable 2, Sortino ratio: 0.017; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 5-year, with fund size; 
Outcome variable 1, Sharpe ratio: 0.001; 
Outcome variable 2, Sortino ratio: -0.001; 
Average percentage change in non-SRI coefficient with controls: -100%. 

Time frame and control variables: 5-year, with strategy categories; 
Outcome variable 1, Sharpe ratio: 0.009; 
Outcome variable 2, Sortino ratio: 0.010; 
Average percentage change in non-SRI coefficient with controls: -37%. 

Time frame and control variables: 5-year, with all controls; 
Outcome variable 1, Sharpe ratio: -0.004; 
Outcome variable 2, Sortino ratio: -0.008; 
Average percentage change in non-SRI coefficient with controls: -139%. 

Time frame and control variables: 10-year, without control variables; 
Outcome variable 1, Sharpe ratio: 0.077; 
Outcome variable 2, Sortino ratio: 0.110; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 10-year, with fund size; 
Outcome variable 1, Sharpe ratio: 0.054; 
Outcome variable 2, Sortino ratio: 0.077; 
Average percentage change in non-SRI coefficient with controls: -30%. 

Time frame and control variables: 10-year, with strategy categories; 
Outcome variable 1, Sharpe ratio: 0.044; 
Outcome variable 2, Sortino ratio: 0.061; 
Average percentage change in non-SRI coefficient with controls: -44%. 

Time frame and control variables: 10-year, with all controls; 
Outcome variable 1, Sharpe ratio: 0.02; 
Outcome variable 2, Sortino ratio: 0.027; 
Average percentage change in non-SRI coefficient with controls: -75%. 

Time frame and control variables: 15-year, without control variables; 
Outcome variable 1, Sharpe ratio: 0.026; 
Outcome variable 2, Sortino ratio: 0.037; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 15-year, with fund size; 
Outcome variable 1, Sharpe ratio: 0.002; 
Outcome variable 2, Sortino ratio: 0.002; 
Average percentage change in non-SRI coefficient with controls: -95%. 

Time frame and control variables: 15-year, with strategy categories; 
Outcome variable 1, Sharpe ratio: 0.009; 
Outcome variable 2, Sortino ratio: 0.011; 
Average percentage change in non-SRI coefficient with controls: -68%. 

Time frame and control variables: 15-year, with all controls; 
Outcome variable 1, Sharpe ratio: -0.015; 
Outcome variable 2, Sortino ratio: -0.024; 
Average percentage change in non-SRI coefficient with controls: -161%. 

Average change in coefficient across all time periods with inclusion 
of fund size categories; 
Average percentage change in non-SRI coefficient with controls: -75%. 

Average change in coefficient across all time periods with inclusion 
of fund strategy control variables; 
Average percentage change in non-SRI coefficient with controls: -50%. 

Average change in coefficient across all time periods with inclusion 
of full set of controls; 
Average percentage change in non-SRI coefficient with controls: -125%. 

Source: GAO analysis of data received from Morningstar, Inc. 

[End of table] 

As shown above, the Sharpe ratio served as the outcome variable for 
the first set of regressions (second column of the table). The Sortino 
ratio served as the outcome variable for the second set of regressions 
(third column of the table). The last column shows the average impact 
on the non-SRI flag coefficient of inclusion of the control variables 
for the row. For each outcome variable, inclusion of the control 
variables generally reduced the estimated performance premium of non-
SRI funds versus SRI funds. The fund size and strategy variable sets 
both had substantial impacts on the estimated difference in SRI and 
non-SRI fund performance. 

The rows of the table show regression results for the 5-, 10-, and 15-
year time frames. The rows indicating no control variables included 
only the non-SRI flag. The rows indicating "with fund size" included 
fund size, along with the SRI variable as explanatory variables. 
[Footnote 44] The row indicating Year: with strategy categories 
include controls for whether a fund is actively managed or passively 
tracks an index, the broad investment category of a fund based on 
portfolio statistics and composition (e.g., natural resources, real 
estate, or financial), the more narrowly defined institutional 
investment category of a fund based on portfolio statistics and 
composition (e.g., materials, domestic energy, technology, or 
utilities), and the market capitalization and type of stock (value, 
blend, and growth). The row indicating Year: with all controls 
provides results for regressions with share class as an explanatory 
variable in addition to the fund size and strategy variables.[Footnote 
45] 

Table 3 shows results from 24 regressions for balanced funds. The 
methodology for these regressions was the same as that used for the 
regressions in table 2. Accounting for covariates did not have a 
consistent impact on the estimated difference in performance between 
SRI and non-SRI funds for these funds, with the addition of control 
variables to the regressions sometimes increasing the estimated 
difference in performance and sometimes decreasing it. 

Table 3: Regression Coefficients on Non-SRI Indicator: U.S. Balanced 
Funds, Institutional, Front-load, and No-load Share Classes: 

Time frame and control variables: 5-year, without control variables; 
Outcome variable 1 Sharpe ratio: 0.057; 
Outcome variable 2: Sortino ratio: 0.082; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 5-year, with fund size; 
Outcome variable 1 Sharpe ratio: 0.040; 
Outcome variable 2: Sortino ratio: 0.060; 
Average percentage change in non-SRI coefficient with controls: -28%. 

Time frame and control variables: 5-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: 0.078; 
Outcome variable 2: Sortino ratio: 0.112; 
Average percentage change in non-SRI coefficient with controls: 37%. 

Time frame and control variables: 5-year, with all controls; 
Outcome variable 1 Sharpe ratio: 0.063; 
Outcome variable 2: Sortino ratio: 0.09; 
Average percentage change in non-SRI coefficient with controls: 10%. 

Time frame and control variables: 10-year, without control variables; 
Outcome variable 1 Sharpe ratio: 0.164; 
Outcome variable 2: Sortino ratio: 0.241; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 10-year, with fund size; 
Outcome variable 1 Sharpe ratio: 0.130; 
Outcome variable 2: Sortino ratio: 0.191; 
Average percentage change in non-SRI coefficient with controls: -21%. 

Time frame and control variables: 10-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: 0.148; 
Outcome variable 2: Sortino ratio: 0.217; 
Average percentage change in non-SRI coefficient with controls: -1%. 

Time frame and control variables: 10-year, with all controls; 
Outcome variable 1 Sharpe ratio: 0.125; 
Outcome variable 2: Sortino ratio: 0.185; 
Average percentage change in non-SRI coefficient with controls: -23%. 

Time frame and control variables: 15-year, without control variables; 
Outcome variable 1 Sharpe ratio: 0.111; 
Outcome variable 2: Sortino ratio: 0.166; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 15-year, with fund size; 
Outcome variable 1 Sharpe ratio: 0.056; 
Outcome variable 2: Sortino ratio: 0.083; 
Average percentage change in non-SRI coefficient with controls: -50%. 

Time frame and control variables: 15-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: 0.094; 
Outcome variable 2: Sortino ratio: 0.139; 
Average percentage change in non-SRI coefficient with controls: -16%. 

Time frame and control variables: with all controls; 
Outcome variable 1 Sharpe ratio: 0.063; 
Outcome variable 2: Sortino ratio: 0.093; 
Average percentage change in non-SRI coefficient with controls: -43%. 

Average change in coefficient across all time periods with inclusion 
of fund size categories; 
Average percentage change in non-SRI coefficient with controls: -33%. 

Average change in coefficient across all time periods with inclusion 
of fund strategy control variables; 
Average percentage change in non-SRI coefficient with controls: 4%. 

Average change in coefficient across all time periods with inclusion 
of full set of controls; 
Average percentage change in non-SRI coefficient with controls: -19%. 

Source: GAO analysis of data received from Morningstar, Inc. 

[End of table] 

Table 4 shows results for 24 regressions for bond funds. The 
methodology for these regressions was the same as that used for the 
regressions in table 2 except that one field (equity style box) was 
not included as an explanatory variable because it was not populated 
for 90 percent of these funds. Accounting for covariates generally 
decreased the estimated difference in performance between the SRI and 
non-SRI funds. 

Table 4: Regression Coefficients on Non-SRI Indicator: U.S. Bond 
Funds, Institutional, Front-load, and No-load Share Classes: 

Time frame and control variables: 5-year, without control variables; 
Outcome variable 1 Sharpe ratio: -0.264; 
Outcome variable 2 Sortino ratio: -0.452; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 5-year, with fund size; 
Outcome variable 1 Sharpe ratio: -0.277; 
Outcome variable 2 Sortino ratio: -0.486; 
Average percentage change in non-SRI coefficient with controls: -6%. 

Time frame and control variables: 5-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: -0.028; 
Outcome variable 2 Sortino ratio: 0.055; 
Average percentage change in non-SRI coefficient with controls: 101%. 

Time frame and control variables: 5-year, with all controls; 
Outcome variable 1 Sharpe ratio: -0.028; 
Outcome variable 2 Sortino ratio: 0.037; 
Average percentage change in non-SRI coefficient with controls: 99%. 

Time frame and control variables: 10-year, without control variables; 
Outcome variable 1 Sharpe ratio: -0.154; 
Outcome variable 2 Sortino ratio: -0.222; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 10-year, with fund size; 
Outcome variable 1 Sharpe ratio: -0.159; 
Outcome variable 2 Sortino ratio: -0.235; 
Average percentage change in non-SRI coefficient with controls: -5%. 

Time frame and control variables: 10-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: -0.006; 
Outcome variable 2 Sortino ratio: 0.047; 
Average percentage change in non-SRI coefficient with controls: 109%. 

Time frame and control variables: 10-year, with all controls; 
Outcome variable 1 Sharpe ratio: -0.005; 
Outcome variable 2 Sortino ratio: 0.045; 
Average percentage change in non-SRI coefficient with controls: 109%. 

Time frame and control variables: 15-year, without control variables; 
Outcome variable 1 Sharpe ratio: -0.252; 
Outcome variable 2 Sortino ratio: -0.380; 
Average percentage change in non-SRI coefficient with controls: 
[Empty]. 

Time frame and control variables: 15-year, with fund size; 
Outcome variable 1 Sharpe ratio: -0.250; 
Outcome variable 2 Sortino ratio: -0.375; 
Average percentage change in non-SRI coefficient with controls: 1%. 

Time frame and control variables: 15-year, with strategy categories; 
Outcome variable 1 Sharpe ratio: -0.071; 
Outcome variable 2 Sortino ratio: -0.085; 
Average percentage change in non-SRI coefficient with controls: 75%. 

Time frame and control variables: 15-year, with all controls; 
Outcome variable 1 Sharpe ratio: -0.065; 
Outcome variable 2 Sortino ratio: -0.072; 
Average percentage change in non-SRI coefficient with controls: 78%. 

Average change in coefficient across all time periods with inclusion 
of fund size variables; 
Average percentage change in non-SRI coefficient with controls: -3%. 

Average change in coefficient across all time periods with inclusion 
of fund strategy control variables; 
Average percentage change in non-SRI coefficient with controls: 95%. 

Average change in coefficient across all time periods with inclusion 
of full set of controls; 
Average percentage change in non-SRI coefficient with controls: 95%. 

Source: GAO analysis of data received from Morningstar, Inc. 

[End of table] 

To investigate disparities between SRI and non-SRI mutual fund costs, 
we ran regressions that controlled for fund size, share class, and 
investment strategy. The coefficient for a flag indicating SRI status 
is reported for four regressions in table 5. The regression reported 
in the third column used fund size categories along with the SRI 
variable as explanatory variables. The strategy variables used in the 
regressions reported in the fourth and fifth columns were the same as 
those used for the performance regressions reported above. Once the 
fund size and investment strategy variables are taken into account, 
the estimated difference in cost between SRI and non-SRI funds falls 
to 0.06 percent. 

Table 5: Coefficient on SRI Indicator in Regression with Annual Report 
Net Expense Ratio as Dependent Variable With and Without Control 
Variables: 

Estimated percentage point difference in cost between SRI and non-SRI 
mutual funds; 
No control variables: 0.20%; 
Control variables: 
Fund size categories: 0.15%; 
Strategy variables: 0.12%; 
Strategy share class, and fund size categories: 0.06%. 

Source: GAO analysis of mutual fund annual report net-expense ratio 
data received from Morningstar Inc. 

[End of table] 

We assessed the reliability of the quantitative data used in this 
engagement provided by Morningstar by reviewing related documentation, 
interviewing knowledgeable officials, reviewing related internal 
controls, comparing to published data, and tracing a selection of data 
to source documentation. Based on this evaluation, we determined these 
data were reliable for the purposes of this report. We supplemented 
our quantitative analysis with qualitative data obtained from our 
interviews. 

[End of section] 

Appendix II: Variation of Annual Compound Rates of Return and Standard 
Deviation among Evenly Distributed Allocations of the Best Performing 
SRI Stock Index and Existing TSP Stock Index Funds, 1992 through 2011: 

Allocations: Existing TSP Funds (C, S, I) (baseline); 
Change in compound rate of return from baseline (percentage per year): 
0.00%; 
Change in standard deviation from baseline (percentage overall): 0.00%. 

Allocations: SRI ,C, S, I; 
Change in compound rate of return from baseline (percentage per 
year): -0.18%; 
Change in standard deviation from baseline (percentage overall): -
0.24%. 

Allocations: SRI, C, I; 
Change in compound rate of return from baseline (percentage per ear): 
-0.75; 
Change in standard deviation from baseline (percentage overall): -
0.57%. 

Allocations: SRI, C, S; 
Change in compound rate of return from baseline (percentage per year): 
0.39%; 
Change in standard deviation from baseline (percentage overall): 0.12%. 

Allocations: SRI, S, I; 
Change in compound rate of return from baseline (percentage per year): 
-0.43%; 
Change in standard deviation from baseline (percentage overall): 0.03%. 

Allocations: SRI, C; 
Change in compound rate of return from baseline (percentage per 
year): -0.20%; 
Change in standard deviation from baseline (percentage overall): -
0.06%. 

Allocations: SRI, S; 
Change in compound rate of return from baseline (percentage per year): 
0.33%; 
Change in standard deviation from baseline (percentage overall): 0.47%. 

Allocations: SRI, I; 
Change in compound rate of return from baseline (percentage per year): 
-1.42%; 
Change in standard deviation from baseline (percentage overall): -
0.33%. 

Allocations: SRI Fund only; 
Change in compound rate of return from baseline (percentage per ear): 
-0.88%; 
Change in standard deviation from baseline (percentage overall): 0.21%. 

Allocations: C Fund only; 
Change in compound rate of return from baseline (percentage per year): 
0.46%; 
Change in standard deviation from baseline (percentage overall): -
0.24%. 

Allocations: S Fund only; 
Change in compound rate of return from baseline (percentage per year): 
1.38%; 
Change in standard deviation from baseline (percentage overall): 1.79%. 

Allocations: I Fund only; 
Change in compound rate of return from baseline (percentage per ear): 
-2.41%; 
Change in standard deviation from baseline (percentage overall): 2.00%. 

Source: GAO analysis of annual rates of total return based on monthly 
total return data from Morningstar, Inc. 

[End of table] 

[End of section] 

Appendix III: Additional Information on the Performance of SRI and Non-
SRI Mutual Funds by Asset Class: 

Our analysis of institutional-grade mutual funds over the last 5, 10, 
and 15 years (dating back from December 2011) showed that SRI bond 
mutual funds had better risk-adjusted performance than their non-SRI 
counterparts, while SRI stock and SRI balanced funds did not.[Footnote 
46] Specifically, we reviewed measures of risk-adjusted performance 
including the Sharpe and Sortino ratios. Morningstar Inc. defines 
these ratios as follows: 

* Sharpe ratio. This statistic is a reward to variability ratio, which 
offers a means of locating an optimal risky portfolio. The equation is: 

[Refer to PDF for equation] 

rA= expected return on the series or portfolio: 

ó= the standard deviation: 

rF= the risk-free rate: 

And where standard deviation is: 

[Refer to PDF for equation] 

Where: 

ó= the Greek letter commonly used to denote standard deviation: 

rt= expected return on the series or portfolio: 

= the arithmetic mean of the return series r: 

n= the number of periods: 

* Sortino ratio. The Sortino ratio is a risk adjusted return ratio 
that considers excess return over a designated target return and the 
risk of not achieving that target return. Excess return is defined as 
the series' return less the target return; risk is considered to be 
the semi-standard deviation below the target return. The Sortino ratio 
therefore tells you how well you are being compensated by a series for 
each unit of shortfall risk you are incurring. 

The formula for the Sortino ratio: 

Where: 

T= target return: 

SD= the target semi-standard deviation of the return series in 
question over the period in question. This is the square root of the 
target semi-variance, with T as the target return: 

the arithmetic average return of the return series in question over 
the period in question: 

The following tables provide additional information on risk-adjusted 
performance of SRI and non-SRI mutual funds by asset class. 

Bond Mutual Funds: 

Table 6: Sharpe Ratio SRI and Non-SRI Bond Mutual Funds: 

Type of fund: SRI; 

Measure: Mean; 
Annualized time period: 5 year: 1.02; 
Annualized time period: 10 year: 0.82; 
Annualized time period: 15 year: 0.77. 

Measure: Median; 
Annualized time period: 5 year: 1.00; 
Annualized time period: 10 year: 0.87; 
Annualized time period: 15 year: 0.75. 

Measure: Maximum; 
Annualized time period: 5 year: 1.53; 
Annualized time period: 10 year: 1.20; 
Annualized time period: 15 year: 0.84. 

Measure: Minimum; 
Annualized time period: 5 year: 0.27; 
Annualized time period: 10 year: 0.38; 
Annualized time period: 15 year: 0.73. 

Measure: Number; 
Annualized time period: 18; 
Annualized time period: 17; 
Annualized time period: 4. 

Type of fund: Non-SRI; 

Measure: Mean; 
Annualized time period: 5 year: 0.76; 
Annualized time period: 10 year: 0.66; 
Annualized time period: 15 year: 0.52. 

Measure: Median; 
Annualized time period: 5 year: 0.68; 
Annualized time period: 10 year: 0.64; 
Annualized time period: 15 year: 0.48. 

Measure: Maximum; 
Annualized time period: 5 year: 2.82; 
Annualized time period: 10 year: 2.05; 
Annualized time period: 15 year: 1.84. 

Measure: Minimum; 
Annualized time period: 5 year: -2.98; 
Annualized time period: 10 year: -2.09; 
Annualized time period: 15 year: -2.71. 

Measure: Number; 
Annualized time period: 2,103; 
Annualized time period: 1,799; 
Annualized time period: 1,449. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

Table 7: Sortino Ratio SRI and Non-SRI Bond Mutual Funds: 

Type of fund: SRI: 

Measure: Mean; 
Annualized time period: 5 year: 1.80; 
Annualized time period: 10 year: 1.27; 
Annualized time period: 15 year: 1.19. 

Measure: Median; 
Annualized time period: 5 year: 1.69; 
Annualized time period: 10 year: 1.32; 
Annualized time period: 15 year: 1.19. 

Measure: Maximum; 
Annualized time period: 5 year: 3.01; 
Annualized time period: 10 year: 2.15; 
Annualized time period: 15 year: 1.28. 

Measure: Minimum; 
Annualized time period: 5 year: 0.36; 
Annualized time period: 10 year: 0.51; 
Annualized time period: 15 year: 1.09. 

Measure: Number; 
Annualized time period: 5 year: 18; 
Annualized time period: 10 year: 17; 
Annualized time period: 15 year: 4. 

Type of fund: Non-SRI: 

Measure: Mean; 
Annualized time period: 5 year: 1.35; 
Annualized time period: 10 year: 1.05; 
Annualized time period: 15 year: 0.81. 

Measure: Median; 
Annualized time period: 5 year: 1.04; 
Annualized time period: 10 year: 0.96; 
Annualized time period: 15 year: 0.71. 

Measure: Maximum; 
Annualized time period: 5 year: 14.80; 
Annualized time period: 10 year: 3.96; 
Annualized time period: 15 year: 3.69. 

Measure: Minimum; 
Annualized time period: 5 year: -2.48; 
Annualized time period: 10 year: -2.60; 
Annualized time period: 15 year: -2.76. 

Measure: Number; 
Annualized time period: 5 year: 2,103; 
Annualized time period: 10 year: 1,799; 
Annualized time period: 15 year: 1,449. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

Stock Mutual Funds: 

Table 8: Sharpe Ratio SRI and Non-SRI Stock Mutual Funds: 

Type of fund: SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.05; 
Annualized time period: 10 year: 0.14; 
Annualized time period: 15 year: 0.24. 

Measure: Median; 
Annualized time period: 5 year: 0.06; 
Annualized time period: 10 year: 0.12; 
Annualized time period: 15 year: 0.23. 

Measure: Maximum; 
Annualized time period: 5 year: 0.33; 
Annualized time period: 10 year: 0.52; 
Annualized time period: 15 year: 0.47. 

Measure: Minimum; 
Annualized time period: 5 year: -0.49; 
Annualized time period: 10 year: -0.05; 
Annualized time period: 15 year: -0.01. 

Measure: Non-SRI: Number; 
Annualized time period: 86; 
Annualized time period: 68; 
Annualized time period: 37. 

Type of fund: Non-SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.07; 
Annualized time period: 10 year: 0.22; 
Annualized time period: 15 year: 0.27. 

Measure: Median; 
Annualized time period: 5 year: 0.06; 
Annualized time period: 10 year: 0.20; 
Annualized time period: 15 year: 0.26. 

Measure: Maximum; 
Annualized time period: 5 year: 0.73; 
Annualized time period: 10 year: 0.68; 
Annualized time period: 15 year: 0.72. 

Measure: Minimum; 
Annualized time period: 5 year: -0.94; 
Annualized time period: 10 year: -0.38; 
Annualized time period: 15 year: -0.13. 

Measure: Measure: Number; 
Annualized time period: 3,165; 
Annualized time period: 2,466; 
Annualized time period: 1,431. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

Table 9: Sortino Ratio SRI and Non-SRI Stock Mutual Funds: 

Type of fund: SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.08; 
Annualized time period: 10 year: 0.20; 
Annualized time period: 15 year: 0.35. 

Measure: Median; 
Annualized time period: 5 year: 0.09; 
Annualized time period: 10 year: 0.17; 
Annualized time period: 15 year: 0.33. 

Measure: Maximum; 
Annualized time period: 5 year: 0.50; 
Annualized time period: 10 year: 0.78; 
Annualized time period: 15 year: 0.69. 

Measure: Minimum; 
Annualized time period: 5 year: -0.57; 
Annualized time period: 10 year: -0.06; 
Annualized time period: 15 year: -0.01. 

Measure: Number; 
Annualized time period: 5 year: 86; 
Annualized time period: 10 year: 68; 
Annualized time period: 15 year: 37. 

Type of fund: Non-SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.10; 
Annualized time period: 10 year: 0.31; 
Annualized time period: 15 year: 0.39. 

Measure: Median; 
Annualized time period: 5 year: 0.09; 
Annualized time period: 10 year: 0.28; 
Annualized time period: 15 year: 0.37. 

Measure: Maximum; 
Annualized time period: 5 year: 1.29; 
Annualized time period: 10 year: 1.04; 
Annualized time period: 15 year: 1.12. 

Measure: Minimum; 
Annualized time period: 5 year: -1.02; 
Annualized time period: 10 year: -0.45; 
Annualized time period: 15 year: -0.16. 

Measure: Number; 
Annualized time period: 5 year: 3,165; 
Annualized time period: 10 year: 2,466; 
Annualized time period: 15 year: 1,431. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

Balanced Mutual Funds: 

Table 10: Sharpe Ratio SRI and Non-SRI Balanced Mutual Funds: 

Type of fund: SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.05; 
Annualized time period: 10 year: 0.13; 
Annualized time period: 15 year: 0.21. 

Measure: Median; 
Annualized time period: 5 year: 0.02; 
Annualized time period: 10 year: 0.15; 
Annualized time period: 15 year: 0.20. 

Measure: Maximum; 
Annualized time period: 5 year: 0.38; 
Annualized time period: 10 year: 0.23; 
Annualized time period: 15 year: 0.36. 

Measure: Minimum; 
Annualized time period: 5 year: -0.15; 
Annualized time period: 10 year: -0.16; 
Annualized time period: 15 year: -0.02. 

Measure: Number; 
Annualized time period: 5 year: 20; 
Annualized time period: 10 year: 13; 
Annualized time period: 15 year: 8. 

Type of fund: Non-SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.11; 
Annualized time period: 10 year: 0.29; 
Annualized time period: 15 year: 0.32. 

Measure: Median; 
Annualized time period: 5 year: 0.09; 
Annualized time period: 10 year: 0.27; 
Annualized time period: 15 year: 0.30. 

Measure: Maximum; 
Annualized time period: 5 year: 0.89; 
Annualized time period: 10 year: 0.95; 
Annualized time period: 15 year: 0.78. 

Measure: Minimum; 
Annualized time period: 5 year: -1.20; 
Annualized time period: 10 year: -1.18; 
Annualized time period: 15 year: -0.93. 

Measure: Measure: Number; 
Annualized time period: 5 year: 897; 
Annualized time period: 10 year: 454; 
Annualized time period: 15 year: 318. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

Table 11: Sortino Ratio SRI and Non-SRI Balanced Mutual Funds: 

Type of fund: SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.07; 
Annualized time period: 10 year: 0.18; 
Annualized time period: 15 year: 0.29. 

Measure: Median; 
Annualized time period: 5 year: 0.02; 
Annualized time period: 10 year: 0.20; 
Annualized time period: 15 year: 0.28. 

Measure: Maximum; 
Annualized time period: 5 year: 0.57; 
Annualized time period: 10 year: 0.31; 
Annualized time period: 15 year: 0.51. 

Measure: Minimum; 
Annualized time period: 5 year: -0.19; 
Annualized time period: 10 year: -0.20; 
Annualized time period: 15 year: -0.03. 

Measure: Number; 
Annualized time period: 5 year: 20; 
Annualized time period: 10 year: 13; 
Annualized time period: 15 year: 8. 

Type of fund: Non-SRI: 

Measure: Mean; 
Annualized time period: 5 year: 0.16; 
Annualized time period: 10 year: 0.42; 
Annualized time period: 15 year: 0.45. 

Measure: Median; 
Annualized time period: 5 year: 0.12; 
Annualized time period: 10 year: 0.38; 
Annualized time period: 15 year: 0.42. 

Measure: Maximum; 
Annualized time period: 5 year: 1.57; 
Annualized time period: 10 year: 1.64; 
Annualized time period: 15 year: 1.32. 

Measure: Minimum; 
Annualized time period: 5 year: -1.26; 
Annualized time period: 10 year: -1.16; 
Annualized time period: 15 year: -1.00. 

Measure: Number; 
Annualized time period: 5 year: 897; 
Annualized time period: 10 year: 454; 
Annualized time period: 15 year: 318. 

Source: GAO analysis of mutual fund performance data received from 
Morningstar, Inc. 

[End of table] 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgment: 

GAO Contact: 

Charles A. Jeszeck, (202) 512-7215 or jeszeckc@gao.gov: 

Staff Acknowledgment: 

In addition to the individual named above, Kimberley Granger, 
Assistant Director; Jonathan S. McMurray, Analyst-in-Charge; James 
Bennett; and Sarah Kaczmarek made significant contributions to this 
report. Kenneth Stockbridge, Roger Thomas, and Jack Wang also made key 
contributions. 

[End of section] 

Footnotes: 

[1] 5 U.S.C.§ 8472. 

[2] The Financial Industry Regulatory Authority defines index funds as 
passive funds that seek to replicate the performance of a market index 
instead of outperforming it. Index funds differ from mutual funds 
which are investment companies that pool money from many investors and 
invest it based on specific investment goals. 

[3] We selected the best performing SRI stock index from the five U.S.-
based SRI stock indices with at least a 10-year history that were 
active as of December 2011. (We identified three other U.S.-based SRI 
stock indices that did not have a 10-year history.) We did not run a 
similar analysis on an SRI bond index because no U.S-based SRI bond 
indices exist. 

[4] Morningstar, Inc., identified three share classes of mutual funds-
-institutional, front-load, and no-load--as the most common share 
classes used by institutional investors. We refer to these three share 
classes together as institutional grade mutual funds. 

[5] FERSA created FERS. As part of FERS, TSP is also part of the 
current three-part retirement system for federal employees, which 
includes Social Security benefits, the basic defined benefit (DB) 
plan, and TSP. The Office of Personnel Management trains retirement 
counselors about each part of the plan. Prior to FERS, most federal 
employees were covered by the Civil Service Retirement System. 

[6] Pension plans may be classified either as DB or as DC plans. DB 
plans promise to provide, generally, a fixed level of monthly 
retirement income for life that is typically determined by a formula 
based on particular factors specified by the plan, such as salary, 
years of service, or age at retirement regardless of how the plan's 
investments perform. In contrast, benefits from DC plans will vary 
with the contributions to and the performance of the investments in 
individual accounts, which may fluctuate in value. 

[7] 5 U.S.C. § 8473. 

[8] Similar to fiduciaries in private pension plan under the Employee 
Retirement Income Security Act of 1974 (ERISA), TSP fiduciaries are 
the persons who have discretionary control or authority over the 
management or administration of the plan, including management of the 
plan's assets. TSP fiduciaries are required to perform their 
responsibilities in the interest of participants and beneficiaries for 
the exclusive purpose of providing benefits to participants and their 
beneficiaries and defraying the reasonable expenses of administering 
the TSP. Other fiduciary responsibilities include the duty to act 
prudently and, to the extent permitted by law, to diversify the 
investment of the fund so as to minimize the risk of large losses, 
unless under the circumstances it is clearly prudent not to do so. 

[9] 5 U.S.C. § 8438(f). 

[10] GAO, Federal Retirement Thrift Investment Board: Many 
Responsibilities and Investment Policies Set by Congress, GAO-07-611 
(Washington, D.C.: June 21, 2007). 

[11] Pub.L.No. 111-31, Div.B, §104, 123 Stat.1852, 1854 (codified at 5 
U.S.C.§ 8438(b)(1)). 

[12] The Roth TSP, as authorized by the Thrift Savings Plan 
Enhancement Act of 2009 (enacted June 22, 2009), allows federal 
civilian employees and members of the uniformed services to contribute 
after-tax dollars into the TSP for the first time. Both the 
contributions and their earnings will be tax-free when withdrawn, as 
long as IRS requirements are met. The Roth TSP option has been 
available to participants since May 2012. 

[13] TSP's 2008 participant survey found that 39 percent of 
respondents said TSP would be a better program if it provided a self-
directed mutual fund window, 24 percent said they would transfer some 
of their TSP account balance, and 10 percent would be willing to pay 
$100 annual fee to use the window. In a 2009 memorandum to the Board, 
the TSP executive director recommended the addition of a mutual fund 
window as an appealing feature to participants who sought more 
specialized or sophisticated TSP investments. Moreover, the window 
would allow participants to invest in funds that better matched their 
individualized risk tolerance or particular interests, such as SRI 
funds. According to the Department of Labor, the Board would need to 
consider the application of FERSA's fiduciary standards to the design 
and operation of such a mutual fund window. 

[14] 5 U.S.C. § 8477(b)(1)(A)(ii). 

[15] According to the Department of Labor, the ERISA fiduciary 
standards governing investment decisions apply to an ERISA fiduciary's 
selection of a "socially responsible" mutual fund as a designated 
investment alternative under a private-sector pension plan. 

[16] Vesting means that the TSP provides that an employee's right to a 
benefit is nonforfeitable upon the attainment of the required period 
of service under the law. 

[17] For more information on these principles, see 
http://www.unpri.org, accessed May 24, 2012. 

[18] US SIF was formerly known as the Social Investment Forum (SIF). 
US SIF is a U.S. membership association for professionals, firms, 
institutions, and organizations engaged in sustainable and responsible 
investing. 

[19] We included responses from officials from three public DB plans 
who, like TSP officials, were responsible for managing plans with 
large asset holdings and large, diverse participant groups. Although 
the fiduciary role of these officials differed significantly from that 
of TSP officials in terms of their ability to pursue SRI, these 
officials identified other challenges that were similar to the 
challenges that TSP officials identified. 

[20] TSP's 2006-2007 participant survey found that none of the 
additional investment options that participants were asked to rate, 
including a socially responsible fund, had a majority of respondents 
who were willing to add the funds if there would be additional costs 
associated with utilizing those funds. 

[21] This range of participation rates in SRI funds is not a 
reflection on SRI as a viable investment option. For example, plans 
with more than 10 investment options could have 10 percent of 
participants investing in each option, including the SRI option. In 
contrast, plans like TSP with fewer investment options might consider 
a 10-percent SRI participation rate low when compared to the 
participation rates in the plan's other investment options. 

[22] According to TSP regulations, the amount of accrued 
administrative expenses not covered by forfeitures (agency 
contributions made to employees who leave federal service before 
vesting) and not directly attributable to an individual fund (such as 
fund management fees) are charged on a pro rata basis to all TSP 
funds, based on the respective fund balances on the last business day 
of the prior month end. 

[23] See Year: Investment Option Review for the Federal Thrift Savings 
Plan,Year: Ennis Knupp and Associates, Oct. 2006. The report is 
accessible on the Board's website: 
http://www.frtib.gov/FOIA/index.html, accessed June 15, 2012. 

[24] TSP's stock portfolio includes TSP's three stock index funds--C 
fund, S fund, and I fund. We did not include a similar analysis of 
bond funds because no U.S.-based SRI bond indices exist. 

[25] For example, four-way combinations allocate 25 percent to each 
fund and three-way combinations allocate 33 percent to each fund. 
Portfolios were rebalanced annually to maintain even distributions. In 
this section, returns are measured by the compound rate of return and 
volatility is measured by standard deviation of annual returns. 
Standard deviation is a statistical measure of the range of a fund's 
performance. When a fund has a high standard deviation, its range of 
performance has been very wide, indicating that there is a greater 
potential for volatility. 

[26] For more information on the annual compound rates of return and 
standard deviation of these funds, see appendix II. 

[27] Investors may pursue SRI for reasons other than portfolio 
diversification, including directing their retirement savings to 
socially responsible companies. 

[28] Other SRI indices may have had more or less overlap with the C 
Fund index. 

[29] Price movements between two funds can be between 0 and 100 
percent independent. The independence of price movements is measured 
by 100 percent independence of price movements less the common 
variance. The common variance is a statistical measure that measures 
independence of price movements, and is the square of the correlation 
coefficient. The correlation coefficient of the two funds was 0.99 
over this time period. Correlation coefficient is a statistical 
measure that falls between -1.0 and +1.0. A coefficient of +1.0 means 
that the two indices move in the same direction at the same time in 
the same (relative) amounts. 

[30] Morningstar identified three share classes of mutual funds--
institutional, front-load and no-load--as the most common share 
classes used by institutional investors. We refer to these three share 
classes together as institutional grade mutual funds. We did not 
analyze other forms of SRI funds such as variable annuities and 
exchange traded funds. Hence, the results of our analysis are not 
generalizable to non-institutional grade mutual funds or to other 
forms of SRI. We included three asset classes of mutual funds in our 
analysis, stocks, bonds, and balanced. Stock funds invest in stocks, 
bond funds invest in bonds, and balanced funds invest in a combination 
of stocks and bonds. Looking at institutional grade share classes of 
mutual funds, we identified: (1) 21 SRI bond mutual funds, 118 SRI 
stock mutual funds, and 30 SRI balanced mutual funds, and (2) 2,403 
non-SRI bond mutual funds, 3,579 non-SRI stock mutual funds, and 1,366 
non-SRI balanced mutual funds active as of December 2011. 

[31] In this section, risk-adjusted returns are measured by Sharpe and 
Sortino ratios. Sharpe ratio is calculated by using standard deviation 
and excess return to determine reward per unit of risk. The higher the 
Sharpe ratio is, the better the fund's historical risk-adjusted 
performance. The Sortino ratio differentiates harmful volatility from 
volatility in general by using a value for downside deviation. The 
Sortino ratio is the excess return over the risk-free rate divided by 
the downside semi-variance. For additional details on performance by 
asset class, see appendix III. 

[32] We ran regressions to control for fund size, share class, and 
investment strategy other than SRI approaches. The investment strategy 
control variables were whether a fund is actively managed or passively 
tracks an index, the broad investment category of a fund based on 
portfolio statistics and composition (e.g., natural resources, real 
estate, or financial), the more narrowly defined institutional 
investment category of a fund based on portfolio statistics and 
composition (e.g., materials, domestic energy, or technology), and the 
market capitalization and type of stock (value, blend, and growth). 

[33] We ran cost regressions to control for fund size, share class, 
and investment strategy other than SRI approaches. 

[34] According to Morningstar, the annual net expense ratio reflects 
the actual fees charged during a particular fiscal year. The expense 
ratio is expressed as the percentage of assets deducted each fiscal 
year for fund expenses. 

[35] In fiscal year 2010, SRI mutual funds had an average net-expense 
ratio of 1.08 percent and non-SRI mutual had an average net-expense 
ratio of 0.88 percent. 

[36] We ran cost regressions to control for fund size, share class, 
and investment strategy other than SRI approaches. 

[37] The Common Stock Index Investment Fund (C Fund) is indexed to the 
Standard & Poor's 500 Index. The Small Capitalization Stock Index 
Investment Fund (S Fund) is indexed to the Dow Jones U.S. Completion 
Total Stock Market Index. The International Stock Index Investment 
Fund (I Fund) is indexed to the Morgan Stanley Capital International 
Europe, Australasia, and Far East Index. 

[38] We selected the best performing SRI stock index from the five 
U.S.-based SRI stock indices with at least a 10-year history that were 
active as of December 2011. Sharpe ratio is calculated by using 
standard deviation and excess return to determine reward per unit of 
risk. As such, the higher the Sharpe ratio, the better the fund's 
historical risk-adjusted performance. 

[39] Specifically, we calculated annualized compound return (i.e., 
geometric average annual return) and standard deviation of annual 
return. Standard deviation is a statistical measure of the range of a 
fund's performance. When a fund has a high standard deviation, its 
range of performance has been very wide, indicating that there is a 
greater potential for volatility. 

[40] Correlation coefficient is a statistical measure that falls 
between -1.0 and +1.0. A coefficient of +1.0 means that the two 
indices move in the same direction at the same time in the same 
(relative) amounts. The independence of price movements is measured by 
100 percent independence of price movements less the common variance. 
The common variance is a statistical measure that measures 
independence of price movements, and is the square of the correlation 
coefficient. 

[41] US SIF was formerly the Social Investment Forum (SIF). US SIF is 
a U.S. membership association for professionals, firms, institutions 
and organizations engaged in sustainable and responsible investing. 

[42] Annual report expense ratios reflect the actual fees charged 
during a particular fiscal year. The expense ratio expresses the 
percentage of assets deducted each fiscal year for fund expenses. 

[43] We do not report standard errors of estimates here because our 
results are based on the universe of mutual funds that fit our 
criteria, rather than a sample. Thus standard errors are not 
applicable. 

[44] The size intervals were determined using an SPSS Decision Tree 
algorithm. The algorithm found six size categories which differed 
significantly from each other in the ratio of SRI to non-SRI funds. 
Breaking fund size into categories allowed including funds without 
fund size data in the analysis, because the missing data were grouped 
into a category. 

[45] We did not include standard deviation as an explanatory variable 
in the regressions because volatility is accounted for in the risk-
adjusted performance measures. 

[46] Morningstar identified three share classes of mutual funds--
institutional, front-load and no-load--as the most common share 
classes used by institutional investors. We refer to these three share 
classes together as institutional grade mutual funds. We did not 
analyze other forms of SRI funds such as variable annuities and 
exchange traded funds. Hence, the results of our analysis are not 
generalizable to non-institutional grade mutual funds or to other 
forms of SRI. We included three asset classes of mutual funds in our 
analysis, stocks, bonds, and balanced. Stock funds invest in stocks, 
bond funds invest in bonds, and balanced funds invest in a combination 
of stocks and bonds. After controlling for fund size and investment 
strategies (other than SRI approaches), we found that the gap between 
the performance of SRI and non-SRI mutual funds narrowed significantly 
for stock funds but not for balanced funds. 

[End of section] 

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