Last week, Investors Against Genocide (IAG) announced that Vanguard will now screen its funds' constituents for human rights practices – including companies' involvement with the government of Sudan. Vanguard says that its new policy, which applies to all 157 of its funds, is "substantially identical" to IAG's shareholder proxy proposals.

"While the SRI mutual fund industry has had policies like this in place for decades, I know of few mainstream firms which have such a clear and explicit human rights policy," Walden Asset Management's Tim Smith told the Social Investment Forum.

Even Passive Funds can Manage ESG Risks

Vanguard is a $1 trillion mutual fund firm that is known for its index funds. IAG notes the significance of Vanguard's application of environmental, social, and governance (ESG) analysis to "passive" investing strategies:

"By applying its new policy to all its funds, Vanguard is demonstrating the feasibility of divesting not only from actively managed funds, but also from funds that track an index. Managers of funds that oppose genocide-free investing have sometimes cited index funds as a reason that they are unable to take action. Vanguard's action demonstrates that both actively and passively managed funds may be structured to avoid complicity in genocide."

"ESG risks, like Sudan involvement or questionable lending practices, can also be red flags for potential financial risks," KLD Index Manager Karin Chamberlain commented. "ESG analysis presents fund managers with a more detailed picture of each corporation's risk profile."

Why Now?

Why, in 2009, has IAG been able to make headway on this issue? One theory, as proposed in a recent Financial Times column, suggests that the economic crisis is a cause. "A Need to Reconnect" asserts that "the cult of shareholder value" – with its focus on short-term financial results – is a casualty of the meltdown:

"The corporate social responsibility movement, on the rise before the crisis, is likely to receive fresh impetus from investors' recognition that companies' narrow search for profits was not always the best strategy."

Confirming that mainstream investors are now taking a more activist stance, here (courtesy of Mr. Smith) is an excerpt from Vanguard's proxy statement:

"…Although the trustees believe that mutual funds are not optimal agents to address social change, they acknowledge that there may be instances when it is appropriate to assess such issues. Accordingly, the trustees directed Vanguard to implement a formal procedure for regular reporting to the trustees on portfolio companies whose direct involvement in crimes against humanity or patterns of egregious abuses of human rights would warrant engagement or potential divestment."

Vanguard's New Policy in Practice

IAG notes that Vanguard's willingness to engage or divest will soon be tested. On March 31, the firm is expected to release an SEC filing on a fund that holds millions of PetroChina shares. PetroChina is a major business partner of the Sudanese government.

"If Vanguard's Emerging Markets Stock Index Fund shows a significant reduction in its holdings of PetroChina, then we will have a clear signal that Vanguard's Trustees are serious about not connecting their customers with the genocide in Darfur," said IAG's Eric Cohen.

For more on the implications of Vanguard's new policy, see Robert Kropp at Social Funds.

Click here for more on the "Sudan and Iran Divestment Campaigns" by KLD Managing Director Randy O'Neil.