(FORTUNE Small Business) – Investing ethically is hardly a new concept--for thousands of years Jewish law has dictated that all business investment should support the entire community--but only in the past few decades has that approach caught on among American investors. Unfortunately, throughout most of the 1990s those investors often had to choose from mutual funds that were well-intentioned but offered wilting returns at best. In fact, a majority of so-called socially responsible funds often lagged behind the overall market.

That's changed recently, though, as the bear market has reoriented the investing universe. According to financial research firm Lipper, so-called socially responsible funds have performed about in line with regular diversified equity funds over the past three-year and five-year periods. Because of that, people who want to keep their money in the market but still sleep well at night have been voting with their dollars. Just last year, at a time when investors withdrew nearly $10.5 billion from diversified U.S. equity funds, they added $1.5 billion to socially responsible investing (SRI) funds. Says Tim Fidler, director of research at Ariel Funds, a Kansas City company that specializes in green investing: "People are realizing you don't need to sacrifice performance."

There are some decided advantages to these investments. A big one is the amount of research behind them. Portfolio managers in the category typically apply rigorous environmental and social screens to their companies, and because of that the fund companies need to do a lot more qualitative research. Result? They get to know their portfolio companies extremely well. "Nothing can replace direct contact with management," says Jerry Dodson, founder of Parnassus Investments, one of the oldest socially responsible investment houses in the country. Hedge fund manager Jane Siebels, who founded Green Cay Asset Management, will go so far as to check out what cars the executives are driving. "Things like that can tell you a lot about the company that you won't get from just an interview with the CEO," she says.

One caution, though, is that "green" can mean different things to different managers. Defense contractors are almost always ruled out, as are cigarette manufacturers and companies that make alcoholic beverages. But beyond those obvious categories the rules become a lot more subjective. For example, some managers will not invest in pharmaceutical firms because of their history of polluting, while others try to applaud their efforts to clean up the industry. Those questions come up with other businesses as well. "Just take a look at Carnival Cruise Lines," says Ariel's Fidler. "They've gotten in trouble for dumping sewage water into the ocean. If it happens once or twice, we're fine with that. If it becomes a recurring problem, then that's a big negative."

There's also the matter of intentions. Pax World Investments flat-out refuses to invest in companies that don't meet its arduous screens. But Siebels doesn't see the value in that approach. "I've found that going to a company and saying you're not going to invest in it has no effect," she says. "There are plenty of other people who will." Instead, she looks at industries traditionally viewed as harmful to the environment, such as oil drilling, and tries to find those rare companies taking active steps to improve their record. Then, as a shareholder, she gains a voice in the management of the company. Many of the leading SRI firms employ similar tactics. Armed with only a shareholder proxy, Calvert Group recently helped persuade Dell Computer to adopt a computer-recycling program.

Because of all the variables and differing approaches, green investing can be mazelike for newcomers. To make your life easier, we've selected a couple of investments that any environmentally conscious investor--in fact, any investor--would be happy to own.

STOCK FUND

Parnassus Equity Income (parnassus.com)

Parnassus Equity Income quickly dispels the myth that socially responsible investing entails sacrificing returns. This fund, which invests primarily in mid- and large-cap stocks that pay dividends, has destroyed the competition over the past five years, outperforming 99% of its large-cap value peers. In 2002 alone, a year in which the S&P 500 declined by over 22%, Equity Income managed to lose just 3.7%. Jerry Dodson, who founded Parnassus Investments in 1984, chalks up the fund's success to its value-oriented bent, which tends to limit a stock's downside. "We only invest in stocks trading at two-thirds of what we consider their intrinsic value," he says.

Dodson handed over the day-to-day reins of Equity Income in 2001 to manager Todd Ahlsten so that he could focus on the less conservative Parnassus fund. So far Ahlsten has done a good job of meeting and even exceeding his mentor's performance. Last year Equity Income outpaced Parnassus, which took a beating on telecommunications stocks. "Telecom looked cheap at the time, but we completely missed how overbuilt the infrastructure was," Dodson explains. Currently both funds are betting big on health care. With more than a quarter of the funds' assets in that sector, Dodson says, it's not only a defensive play in a rough economy. "We just see a lot of good values there," he says.

Similarly, Dodson likes a company called Baldor Electric (BEZ), a manufacturer of environmentally friendly electric motors that power everything from pencil sharpeners to backup generators. In the industry they're considered "mid-sized" motors, and Baldor is the market leader, with a 32% share. Now, however, it's developing bigger motors--venturing into territory currently dominated by companies like GE and Emerson Electric. To compete, Dodson says, Baldor has come up with a low-emission generator half the size of diesel-powered options. It produces the same amount of energy, costs $5,000 less, and spits out no emissions because it runs entirely on natural gas.

BOND FUND

Calvert Social Investment Bond (calvertgroup.com)

Manager Greg Habeeb buys the bonds of companies that pass rigorous environmental and social screens, with one small twist: He turns over the entire portfolio 955% a year, while the average intermediate-term bond fund clocks in at 227%. In other words, Habeeb is buying and selling all his holdings almost every month. This hyperactive style is intended to keep the average bond duration (i.e., the time till the bonds mature) fairly constant. You'd expect such active management to lead to higher expenses (it doesn't) and to higher taxes (it does), but Habeeb still bested his group average over the past five years. Moreover, about 59% of the fund is invested in AAA corporate bonds, the highest corporate rating, and almost 95% of it is in investment-grade bonds, so shareholders don't need to be concerned with the credit problems that can plague other bond funds.

With interest rates at their lowest point in decades and economists scratching their heads, Habeeb is hedging against a potential rise in interest rates by investing 65% of the fund in bonds with durations of three years or under and another 22% in ten years or over. Reno Martini, chief investment officer, explains that it's a kind of hedge. "No matter where interest rates go," he says, "we think we'll be able to handle it."

STOCK AND BOND FUND

Pax World Balanced fund (paxfund.com)

Launched in 1971, Pax World Balanced was the first socially responsible fund in the U.S. And although the original portfolio manager, Anthony Brown, retired in 1998, his son, Christopher, has since followed many of the same rules that have made this fund so successful. But unlike his father, a firm domestic value investor, Christopher Brown has no problem with investing in growth stocks both here and overseas. "We've broadened our horizons," he says. "I've moved into technology and ADRs [American depositary receipts, representing stock of foreign companies, which are traded on U.S. exchanges], and I'm less reliant on traditional consumer staples and consumer cyclicals."

It's working. While maintaining a fairly conservative split of 60% stocks and 25% investment-grade bonds, Brown has beaten 90% of his competitors since taking over the fund. In the past five years he's outpaced the S&P 500 by more than 6.5 percentage points a year. And he's done all that while ensuring below-average risk. Tax-conscious investors will also be pleasantly surprised at the fund's low turnover of around 30%.

Right now Brown's hot on home-improvement superstore Lowe's (LOW), a beneficiary of the recent housing boom. It's doing well against Home Depot in metropolitan areas, Brown says, and it continues to grow its margins through new product lines. Making Lowe's even more attractive is its maintenance of a Healthy Forests Advisory Board that addresses ongoing environmental issues like illegal logging in foreign countries, and every one of its employees receives training in ways to minimize waste and reduce pollution.

INDEX FUND

Vanguard Calvert Social Index fund (calvertgroup.com)

For investors who prefer index funds, Vanguard Calvert Social Index has shown promise in the three years since it was launched. As with any index fund, manager George Sauter invests in a set list of stocks--in this case the Calvert Social Index--rather than actively picking and choosing his investments. Calvert starts out with the 1,000 largest companies in the country and applies a couple of different screens to rule out companies with, say, bad environmental records or labor practices. The final list includes about 650 names, and most of the top holdings are similar to what you'd find in most major index funds--Microsoft, Johnson & Johnson, IBM, Bank of America.

What you won't find, though, are the corporate bad boys that didn't make it through the screens. For example, Cree (CREE), a maker of light-emitting diodes for things like car dashboards and video monitors, was booted in June 2002 because the company's production plants are increasing their output of toxins. And in December 2002, Computer Associates (CA) was taken off the index because of a pile of shareholder lawsuits. (A Cree spokeswoman says the company is taking steps to reduce emissions, and CA has replaced most of its board since the company's financial problems started.)

Calvert runs its own index fund--with an identical list of portfolio holdings--so why go to Vanguard? Expenses, expenses, expenses. Since they both invest in the same stocks in the same proportions, the only difference is the expense ratio. Vanguard's fund is 20 basis points cheaper, which has permitted Sauter to eke out slightly better gains over time.

HEDGE FUND

Green Cay Asset Management (greencayasset.com)

Jane Siebels, founder of hedge fund shop Green Cay Asset Management, thinks Wall Street has lost its way in the past decade. "They rely too much on computer-driven quantitative analysis at the expense of nitty-gritty qualitative research," she says. Green Cay's socially responsible mandate requires her to kick the tires on all the companies she's looking to buy--interviewing management, the board, even interviewing workers at the 7-Eleven near a company headquarters to see what they think of its operation. To her, it's just good investing sense. "If you look at Warren Buffett, he's essentially doing the same thing," she says. "He's talking not only about the financial side, but the values of the company." Her methods have thus far paid off. Hedge funds aren't regulated by the SEC, so her results aren't made public, but Siebels's four funds--Emerging Markets, American Relative Value, Hard Assets, and Global Technology--have handily beaten the S&P 500 since inception, and all four are in the top quartile of their respective categories.

Hedge funds aren't for everyone, and Green Cay is no exception. To qualify, you need $5 million in liquid assets, plus a $1 million initial investment. And the performance at some of them can be volatile, because the managers are short-selling the stock of companies they expect to underperform. (Essentially, short-selling is the old adage of "Buy low, sell high" in reverse. That is, short-sellers borrow stock to sell, with the promise that they will buy those shares back in the future, hopefully at a lower price).

In a twist, though, Siebels shorts companies that don't meet Green Cay's social criteria. Examples? She shorted Enron, Tyco, WorldCom, and Dynegy long before the market caught on to their problems. "We identified the bad underlying corporate values even though their underlying businesses looked pretty good at the time," she says.

PRIVATE ASSET MANAGEMENT

Walden Asset Management (waldenassetmgmt.com)

If you have the means, another option is to hire your own private money manager. Walden Asset Management, which has been in business for nearly 30 years, requires a $1 million investment and will assign you a manager to custom tailor a socially responsible investment portfolio. They apply the social screens you're most interested in and trade the portfolio to accommodate your specific investment goals. "What's good for one client is not necessarily good for another," says portfolio manager Kenneth Scott. "Often you find clients may be passionate about one issue, like the environment, so we can gear the portfolio to account for that passion."

To the delight of ardent social investors, Walden is far from a passive investment house. It has a five-person team whose sole responsibility is to actively push its portfolio companies to improve corporate values. In the past few years alone, Walden has filed shareholder proxies that have successfully lobbied Coca-Cola and Pepsi to improve their recycling efforts.

ANGEL INVESTING

Investors' Circle (investorscircle.net)

Launched in 1992, Investors' Circle is the oldest angel-investing group in the country. Angels invest in early-stage companies, and the Investors' Circle $1,195 annual membership fee buys you access to 300 deals a year that have been thoroughly vetted to meet financial and socially responsible criteria. That fee also gives you entrance to regular meetings at which CEOs of young companies pitch their ideas. Chairman Woody Tasch adds that there are other intangible benefits, such as networking with people who share the same concerns.

If you're worried that angel investing may be out of your league, Tasch explains that Investors' Circle's 110 members come from different backgrounds with varying levels of financial sophistication. "They range from venture capital funds to first-time investors," he says. While the median investment is about $250,000, members have written checks as small as $10,000 and as large as $5 million. Since 1992, Investors' Circle members have funneled more than $85 million into about 130 small companies and socially responsible venture capital funds. Some of its previous environmentally related investments include Energia Global, a company focused on developing renewable energy that was acquired by Italian electric utility Enel, and Evergreen Solar, a solar power manufacturer that went public in the fall of 2000.