This week, Newsweek released its second annual  Green Rankings of the largest companies in America, as well as a new analysis of big global corporations. These sorts of cross-industry comparisons of companies are difficult to do, but my sense is that Newsweek has done a credible job, with the help of partners MSCI ESG Research, Trucost and CorporateRegister.com. Given the attention that the list is getting,  it seems like a good time to return to a question I’ve thought about for years: Do companies committed to sustainability represent good investment opportunities?

The stock-market performance of Dell, which tops the 2010 list, is not encouraging: The firm’s shares have fallen by 55% during the last five years, while the NASDAQ is up by 18% during the same time period. Of course, one company’s performance over one time period doesn’t prove a thing. It turns out that over the past year, the top 100 companies on the 2009 Newsweek list outperformed the S&P500 by 6.8%.  While this data point doesn’t prove anything either, it’s interesting. So I arranged an email interview with Cary Krosinsky of Trucost to explore the issue further.

Cary Krosinsky

Cary is head of investor and corporate services for North America for Trucost, which is based in the UK. He’s also the author and co-editor, with Nick Robins of HSBC, of Sustainable Investing: The Art of Long Term Performance (Earthscan Publications, 2008), and he has taught classes on investing and sustainability at Columbia.

Marc: Cary, let’s start by defining “sustainable investing.” Is it different from socially responsible investing?

Cary: Socially responsible investing, or SRI, is too broad an investment category.  SRI encompasses very different things—alternative energy investing on the one hand, funds with a religious mandate on the other, as well as funds investing in a mainstream index such as the S&P 500, and subtracting out alcohol, tobacco and firearms.  We see many different styles of SRI.

Sustainable Investing is the more positive strand of SRI – one that is future-oriented, risk-adjusted and opportunity-directed. It looks at what companies can do to lessen risk, as well as capitalize on opportunities, in order to be ahead of the curve in their respective industries. It helps create long-term value, identifies “predictable surprises,” (as opposed to “black swans,”) such as climate change, diminishing water availability, human rights issues and others that influence investment outcomes.  Innovation emerges as a key driver of value through sustainability, as does the active management of environmental impacts.

Marc: It sounds like sustainable investing means identifying the smartest, most forward-thinking companies. In your book, you write that “sustainable investing funds have already outperformed consistently over the short, medium and long term.” How can you support that claim?

Cary: We found that for the 1, 3 and 5 years leading up to the end of 2007, when looking at SRI funds with this positive, opportunity-focused sustainable investing methodology, that they consistently outperformed their mainstream index equivalents.  When updating this study for a UN Principles of Responsible Investment academic paper in 2009, this still held true, both before, through and after the recent financial crisis of 2008 into 2009.

Further correlation of this has been demonstrated by diverse investors including Paul Hawken, who helps manage the Highwater Global Fund as well as Abby Joseph Cohen of Goldman Sachs.  Mark Fulton of Deutsche Bank spoke earlier this year regarding how the climate change sectors they are tracking have been outperforming their benchmarks since the recent market bottom. Matthew Kiernan, formerly of Innovest, now runs money and is also demonstrating outperformance from this more positive approach. The top 100 performers in the Newsweek Green Rankings which we actively participate in at Trucost, have outperformed the S&P 500, on an equally weighted basis, by 6.8% over the last year.

There appears to be an emerging business case that sustainability drives shareholders value.  Our next book for Wiley will focus on how sustainable investors specifically find these opportunities, and how their thinking and methodologies have evolved.

This is in contrast to the first wave of SRI, which used mainly negative approaches. That approach still shapes most SRI assets under management, especially in the US.  Those approaches at best meet market performance as many studies have shown.  One reason why people believe that you can’t make money investing in your values is that these funds are designed to not outperform.

Marc: What do you mean, “designed to not outperform”?

Cary:  The largest SRI fund in the US , the CREF Social Choice Equity Fund,  has a Beta of 1 by design – in effect, it is designed to meet market performance.  And so it doesn’t surprise us when such funds match market performance over time.

The first wave of SRI has been backward looking and frankly somewhat fingerpointing.  Sustainable Investing, unlike this first wave, is very much forward looking, and can find opportunity where it isn’t always expected.

Problems are emerging on a global scale that require innovative solutions, including solving global poverty, and many other issues of inequity.  With global regulation, it is the positive opportunities for corporates that emerge as vital and as a result, most investable as well.

Marc: I’m a fan of Paul Hawken [See: Paul Hawken's winning investment strategy], but his critics say he hasn’t been completely transparent about his results and methodology. Are any of the other managers you mentioned open about what stocks they are picking and their returns? If so, how are they doing?

Cary:  I believe the folks at Highwater would like to be transparent, but they are operating a private fund – I wish a major fund company would have the sense to seize an opportunity to work with Paul, which would remove the transparency issue as well.

A good example of a fund investing this way has been the UK’s Jupiter Ecology Fund – a consistent outperformer that finds novel opportunities.  For example, over the last difficult 5 years, Jupiter Ecology has returned +34% vs. benchmark +26% and a sector average fund return of 18%.  Going back another 5 years, this was the single outperforming fund in its category, so it has a great long-term track record and holds companies for a long time. In fact, for many years its largest two holdings were the same two companies in Vestas Wind Systems, who I’m sure your readers will be familiar with, and Cranswick Plc, a pork producer trying to do things right (which remains the fund’s largest holding as of now).

A “Warren Buffett” approach to sustainable investing–make good bets and stick with them–is starting to emerge as an excellent strategy.  Even the Yale Endowment has been moving in this direction as its most recent report indicates.

Marc:  But there are very few money managers with a track record as good as Buffett’s. In fact, there’s evidence that the majority of actively managed funds underperform market indexes, especially once their higher costs are taken in account. Why would a fund based on the principles of Sustainable Investing be any different?

Cary:  That’s an important point. It has been an ongoing challenge for active managers to outperform passive indexes.  But we are entering a new paradigm – one where innovation is leading to outperformance as has been demonstrated above, and where macro trends are emerging that the mainstream investment community has yet to pick up on in a serious way.

As a result, the opportunity to invest in a sustainable manner remains, and sticking with legacy indexes may be the riskiest strategy of all. Whether it’s peak oil, climate change manifestation, or fresh water shortages, mainstream indexes won’t protect you as they are currently configured.  You may have lower costs temporarily, but longer term, if you take no action, you will have a very high risk profile.

Marc: I know you’d rather not give investment advice but are there any U.S. mutual funds that you see adopting the principles of Sustainable Investing–or at least coming close?

Cary:    That’s what we’ll be exploring in our next book.  At this point, it seems to be early days here in the U.S.  for public practitioners of our investment philosophy.  With a growing awareness of environmental sustainability, and given the outperformance we’ve seen, I honestly don’t know what the investor world is waiting for.

If you are a shareholder in a so-called socially responsible or sustainable mutual fund, you may also be an owner of  BP, the company responsible for the environmental catastrophe in the Gulf of Mexico.

When BP’s oil rig in the Gulf of Mexico exploded on April 20, the company was a major holding of the Dow Jones Sustainability Index–which calls itself an index of “the leading sustainability-driven companies worldwide.”

BP was also held by Pax World Funds (“sustainable investing is a better smarter, way to invest”), by the MMA International Fund, which is part of a fund group that is “guided by Christian values,” and by the Legg Mason Social Awareness Fund, which, as of March 31, had BP as its single biggest holding.

These are not anomalies. When Cary Krosinsky, an editor of a book called Sustainable Investing: The Art of Long Term Performance, tallied up the holdings of about 350 socially responsible investment (SRI) funds from around the world, he found that at the end of 2008, BP was the second biggest holding, in terms of how much money the funds had collectively invested. The five biggest holdings were Royal Dutch Shell, BP, Nokia, Vodafone and HSBC Holdings.

Does this look "sustainable" to you?

What’s more, BP and Shell aren’t the only oil companies held by the social funds. The biggest holding of a mutual fund called the Sentinel Sustainable Core Opportunities Fund–which says it “screens for fundamentally strong, well-managed companies with sustainable business models and a commitment to corporate responsibility”– was, as of March 31, believe it or not….Transocean, the world’s largest offshore drilling contractor, which operated the Deepwater Horizon rig for BP.

While no mutual fund manager could have foreseen the oil rig explosion, you’ve got to wonder how a fund with the word sustainable in its name could have as its biggest holding an offshore oil drilling company. I emailed Sentinel to try to probe their reasoning a bit. You won’t be surprised to hear that they declined to be interviewed.

So what does the BP-SRI connection tell you? At the very minimum, it suggest that any investor in a mutual fund that calls itself socially responsible, sustainable, green, blue or any other color would do well to dig deep beneath the magazine ads and website fluff to understand what the fund is really all about. (Disclosure: I’m a small investor in Calvert and Domini Funds, and a believer in the SRI idea.) Some SRI funds still focus on feel-good, negative screens that shield investors from weapons, tobacco and alcohol, and don’t get much more analytical than that. (See Socially Responsible Investing’s Silly Screens)

As Cary Krosinsky, who now works for Trucost, a research firm that focuses on environmental risks, told me: “The SRI world in the U.S. developed largely around social issues, and it’s still largely focused on values. Some funds don’t look as closely at the environment.”

The other reason why many SRI funds bought BP is that they want to track stock-market indices, and so they seek exposure to the oil and gas sector. Otherwise, when oil company stocks boom, the performance of these funds will suffer.

For social funds that want to buy oil-and-gas stocks, BP and Shell were the obvious choices because they have had more progressive policy positions on climate change and they invested in renewable energy.

Bennett Freeman, senior vice president for sustainability research and policy at Calvert, says that BP under its former CEO, Sir John Browne, in the late 1990s and early 200s, was a pioneer in its approach to corporate responsibility. “It’s easy and appropriate and necessary to criticize them now,” Bennett says, “but these were the guys who broke the crockery in the industry on climate change. The same on human rights.”

Interestingly, Calvert never held BP in its traditional mutual funds, which invest only in companies that meet all of its environmental, social and government standards. But Calvert did own BP in a large-cap value fund which is one of its SAGE funds. SAGE stands for “Sustainability Achieved Through Greater Engagement.” The theory is that by engaging in shareholder advocacy, Calvert will try to to improve the social, environmental and financial performance of its SAGE holdings, which include ExxonMobil, Walmart and Duke Energy. Shareholders in SAGE funds, in other words, cannot expect purity or anything close. Even so, Calvert sold BP in June, explaining its reasoning in this thoughtful and strongly-worded statement.

By contrast, Pax World held BP in one of its traditional SRI funds. As Joe Keefe, Pax’s president and CEO, told me by email: “BP had been on Pax’s approved list prior to the spill and our research indicated that historically it had a good environmental record, good disclosure, etc. vs. its industry peers.” True enough.

But, even prior to the spill, BP had run into some very well-publicized problems: a fire and explosion at a Texas oil refinery in 2005 that killed 15 workers, injured 170 and led to an OSHA fine and censure, serious pipeline problems in Alaska that led to oil leakage and date back to 2006, and civil and criminal charges that BP engaged in price-fixing in the propane market that led to a $303 million settlement with the U.S. government in 2007.

In his email, Joe says that Pax World had put BP on its watch list because of safety problems and decided earlier this spring to sell its shares. Pax divested on April 29–nine days after the spill. “Our process was working,” he writes. I disagree–no socially responsible fund should have held BP after the events outlined above–but I will reprint Joe’s email below so that you can decide for yourself. He deserves credit for his willingness to explain the fund’s thinking.

More credit, though, should go to the social funds managed by Domini and TIAA-CREF, which never held BP at all.

Nor did a relatively small number of funds that focus not on “less bad” companies but instead seek to invest in businesses that are trying to solve environmental or social problems. I’m thinking here about funds like Portfolio 21 and Paul Hawken’s Highwater Global Fund. (See Paul Hawken’s winning investment strategy.)

Because the bottom line for the SRI funds that held BP is this: They owned  a company that turned out to be bad for the planet, bad for their reputation and, at least lately, a very bad investment, too.

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Here’s Joe Keefe’s email to me on PAX and BP:

As you know, many of the ESG/SRI funds owned BP based in part on its reputation as an environmental leader.  I believe it was at one time, and perhaps still is, the largest investor in alternative/renewable energy in the world.

BP had been on Pax’s approved list prior to the spill and our research indicated that historically it had a good environmental record, good disclosure, etc. vs. its industry peers.

In 2009, however, BP was fined $120 million for a Texas refinery explosion that killed 15 workers.  (The explosion actually took place in 2005 but the outcome of the proceedings and fine were apparently rendered/levied in 2009.)  In October 2009, during our annual review of the company, we put the company on a watch list due to safety management concerns, and pursuant to our watch list procedure, we started reviewing BP on a monthly basis.

In March of 2010 we learned that the company had been fined again by OSHA for over 60 safety violations at an Ohio facility.  We therefore put the company under full review again for safety management concerns, a review it ultimately failed, meaning that it no longer met our ESG criteria and was not eligible for investment.  While that review was actually underway, the Gulf Oil explosion/spill occurred.  The company was only held in one of our 11 funds at the time, and the portfolio manager sold the company almost immediately – all 8,000 shares were sold on April 29 – due to concerns over the costs of clean-up, remediation, etc.  (The decision to sell at that point was still optional but would have been mandated a short time later when our company review was complete.)

So, although we owned the company on the date of the spill, my view is that our process was working: we identified a pattern of safety management issues – which the Gulf explosion/spill was an example, really the ultimate example, of – that caused us to put the company on a watch list in October 2009, and then under full re-review in the spring of 2010, which review the company ultimately failed.  Obviously, it just so happened that the BP spill occurred during that re-review – but it could have occurred at any time.  A traditional money manager or mutual fund company that didn’t look at ESG issues and didn’t care about workplace safety issues would not have had a basis for divesting the company, as we did (albeit after, not before, the spill – but again, the spill could have occurred anytime).  My point is, I think our process was working.  It cannot perfectly forecast or avoid all company blow-ups, but I think it helps us to avoid them.  In this case, it is plausible if not likely that we would have divested later – and our shareholders would have lost more value – but for our attention to ESG issues.

Today’s guest post comes from Jeffrey Hollender, the founder, executive chairperson and chief inspired protagonist of Seventh Generation, which makes safe and environmentally-responsible products for the home. Jeff is energetic and multi-talented–he is an entrepreneur, the author of several books, including a brand-new one, The Responsibility Revolution, which he wrote with longtime journalist Bill Breen, a lively blogger at the Inspired Protagonist and an activist who sits on the board of Greenpeace USA. (He’s also a good guy and always has been, at least according to my wife; they went to high school together.) I’m looking forward to reading Jeff’s new book and will review it soon. In the meantime, here’s an edited and expanded version of a recent blogpost that he wrote about the challenges that face consumers who face an onslaught of green and sometimes misleading marketing.

As companies step up their spending on green marketing, the confusion about what’s truly green is getting worse.

For consumers, it’s a challenge to cut through the clutter and decide whether to buy green products or support green companies.

Here’s a guideline that is easy to follow:

We should absolutely not support green products from companies that use them to distract us from their larger negative environmental and social impacts. We need systemically green companies to address the challenges we face, not business-as-usual companies that hold up one green hand while hiding another toxic, CO2-emitting, waste-producing one behind their backs.

Two examples:

The Clorox company has done an impressive job of adding an earth-friendly luster to its image by acquiring Burt’s Bees and launching the GreenWorks line of natural cleaners, which compete with Seventh Generation’s cleaners. But despite its best efforts to renew its image, Clorox can’t quite conceal the fact that at its core, it’s still a big-time bleach company.

Take, for example, a series of ads that the bleach maker ran in early 2009 for its amped-to-the-max cleaner Formula 409. Clorox boasted that it had the desire and the capacity to develop an even brawnier product, Formula 410, “but it would be illegal in twelve states.” The ad implied that if Clorox reformulated 409 just one more time, environmental regulators would ban the chemical-laced product. Perhaps Clorox’s true color is not quite as green as it would like us to believe.

For its part, BP used its “Beyond Petroleum” ad campaign to bolster its green credentials and highlight its comparatively modest spending on renewable energy. But the oil titan’s high-profile rhetoric failed to square with its scarring of a vast wilderness landscape to extract crude from Canada’s tar sands. Not surprisingly, a backlash soon followed. Activists described tar-sands oil extraction as “one of the world’s greatest environmental crimes.”

By the spring of 2009, the oil colossus announced that safety was now its “number one priority,” which led some environmental groups to conclude that the company was retreating to its all-petrol roots. Inevitably, more than a few wags suggested that BP should henceforth stand for “Back to Petroleum.”

To learn how consumers think about greenwashing, New Scientist magazine recently teamed up with EarthSense, which polled U.S. shoppers on their perceptions of the “greenness” of various companies, and with Trucost, which has compiled a quantitative assessment of companies’ global environmental impact.

Together, they looked at whether consumer opinion matched reality. Unfortunately, it didn’t. Take, for example the contrast between Fresh Del Monte Produce and Green Mountain Coffee Roasters. The research concludes that:

Both of these companies are seen by consumers as very environmentally friendly, yet they stand at opposite ends of the spectrum for environmental impact among our sample of food and beverage firms. Words like “fresh” and “green” immediately suggest a wholesome image. This is central to the identity of Green Mountain, a producer of whole-bean and ground coffee, including organically grown varieties. It is, indeed, the greenest of all our food and beverage companies, according to Trucost’s analysis.

Fresh Del Monte Produce similarly projects a green image, but London-based Trucost’s numbers paint a different picture. Growing fruit and vegetables involves heavy use of fertilizers and pesticides, but the main issue again is water consumption, which accounts for more than three-quarters of the company’s high environmental impact score.

That’s quite a gap between belief and truth.

But fear not — the age of transparency is coming as I predict in The Responsibility Revolution, the new book I have written with Bill Breen. Analyses like New Scientist‘s will allow us all to make more responsible decisions, and companies will have a harder and harder time projecting green images while hiding bad habits in their back pockets.

Until it all becomes clear, companies are well advised to use the seven principles for corporate responsibility defined in The Responsibility Revolution, and consumers should make sure that they have the Good Guide loaded on their mobile devices before they go shopping.

You want a car that gets good gas mileage and you want energy-efficient appliances (or at least I hope you do). But do you want a low-carbon investment portfolio?

The Green Century Balanced Fund is betting that you do. The Boston-based mutual fund says it is the first U.S.-based fund to disclose its carbon footprint, which is 66% less than the carbon intensity of the S&P500 Index.

Let’s be clear what we’re talking about here. This isn’t an accounting of how much energy the mutual fund company uses in its offices or how often its staffers get on planes. It’s an analysis of the tons of carbon emissions per million dollars of revenue that are generated by the companies held by the Balanced Fund, compared to the firms in the S&P500.

Why would you care? Not merely because you want to invest in mutual funds and companies that are greener and cleaner than average (although, again, I hope you do) but because those funds and companies will over time outperform their peers—an arguable but much iffier proposition.

In a prepared statement, Simon Thomas, the chief of executive of Trucost, a firm that did the analysis for Green Century, said:

There will clearly be winners and losers from climate change regulation, with companies that are less carbon intensive than their sector peers standing to gain competitive advantage.

While, as they say, past performance is no guide to future returns, the tiny ($47 million in assets under management) Green Century Balanced Fund has, in fact, outperformed the S&P500 Index over the last decade:

The Green Century Balanced Fund’s returns for the one-, three-, five-, and ten-year periods ended June 30, 2009 were -13.36%, -3.78%, -1.05%, and 4.64%, respectively.  The S&P 500® Index returns for the one-, three-, five-, and ten-year periods ended June 30, 2009 were -26.21%, -8.22%, -2.24% and -2.22%, respectively.

Of course, this is partly due the fact that Green Century is a “balanced” fund – as of March 31, it held more than 40% of its assets in cash and bonds – and stocks have underformed cash and bonds lately, to say the least.

Still, there’s a big idea here—that mutual funds, and not just companies, should be required to disclose the carbon footprints of their holdings. To learn more about that, I called up Cary Krosinky, a vice president of Trucost, which is based in the U.K.  I’ve been meaning for some time to reach out to privately-held Trucost because one of its big investors is Robert A.G. Monks, the estimable shareholder advocate who I profiled in FORTUNE (“Investors of the World, Unite!“) back in 2002.

Cary told me that Trucost published two relevant studies on the topic this year—one on the carbon intensity of U.S. mutual funds in April, another on the carbon intensity of the S&P500 in June. The nonprofit Investor Responsibility Research Center (IRRC) commissioned the S&P 500 study, which found not just vast differences in the carbon intensity of companies across sectors (which you would expect) but also major differences within sectors (which you might not.)

If, as now seems likely, Congress passes a cap-and-trade program to regulate carbon emissions and put a price on fossil fuel emissions, the impact on companies would vary widely. Assuming a market price of about $28 per ton of carbon-equivalent emissions, the study says:

Exposure to carbon costs varies significantly across companies in the Index. Carbon costs would amount to less than 1% of EBITDA for 203 companies, while 71 companies could see earnings fall by 10% or more.

And:

Financial risk from carbon costs is greatest in the Utilities sector, where EBITDA at a company level could fall by 2% to 117%.

As for mutual funds, they, too, vary widely in terms of their carbon exposure–sometimes in unexpected ways. Trucost’s report, called Carbon Counts USA, examined the carbon performance of 91 mutual funds in the U.S., including 16 funds that say they focus on sustainability or socially responsible investing. It did not make all the results public, but it said “the footprint of the most carbon-intensive fund is over 38 times larger than the lowest-carbon fund, reflecting the range in potential carbon risk.”

As you’d expect, the 16 funds that focus on sustainability or social investing have, as a group, the smallest carbon footprint, but some are much “greener” than others. Trucost found that the Sentinel Sustainable Core Opportunities Fund has a carbon intensity (692 tons of carbon equivalent emissions per $1 million of revenues of the fund’s holdingss) that is seven times as great as the Ariel Appreciation Fund, which has the smallest footprint (98 tons of carbon equivalent emissions per $1 million in revenues.)

Green Century, meanwhile, reports that its footprint is 126 tons of carbon per $1 million in revenues, bigger than the Ariel Fund but just a bit more than half of the average of the sustainability funds tracked by Trucost. The 10 biggest holdings of the Green Century Balanced Fund, as of March 31, were IBM, AT&T, Xerox, Federal Home Loan Bank of Chicago, General Mills, SLM Corp., Telfonica SA, Johnson & Johnson, Advance Auto Parts and Oracle.

What does this all mean? It’s too soon to say. Only over time will we be able to see whether low carbon stocks and funds, as a group, outperform those with higher carbon exposure. Already, though, some investors are factoring carbon into their long-term view. Trucost is using its data to develop investable indexes of low-carbon companies. “If enough investors look at carbon intensity,” Krosinsky tells me, “it will create a competitive dynamic and encourage companies to become more efficient.” More capital would then flow to clean tech, and less to coal plants like the one below.

Coal power plant, photo by Gustav Knepper, Dortmund Germany