TCS Daily

Saddam Burgers?

By James K. Glassman - April 11, 2005 12:00 AM

In the century he's been on this earth, Roy Neuberger, the former window dresser who invented the no-load mutual fund and made a fortune as an investor, has gained a lot of perspective. "Some people waste their lives in the constant pursuit of great wealth," he wrote in his 1997 book, So Far, So Good: The First 94 Years. As a commodity, let's face it, money doesn't rate as high as good health -- and it certainly isn't up there with great art."

Sure. But don't forget that, without money, fewer people would have good health, or have the opportunity to appreciate great art.

As a hard-nosed investor, my objective, very simply, is to make a lot of money. What I do with that money, after paying taxes, is up to me. I can, for example, buy things that will my family more comfortable, or I can give the money away to institutions that try to make the world a better place, by helping the poor and the sick, by displaying works of art and science that move the soul, and by educating young people.

But am I willing to do anything to make money, even if that money ultimately gets put to good uses? Of course not. If Saddam Hussein were somehow acquitted of crimes against humanity, managed to set up a worldwide chain of restaurants and launch an IPO, would I buy the stock, even if it had a low P/E and great growth prospects? I would not. (Nor would I purchase shares in a Soros Burger chain.) I have my limits. We all do.

Enter socially responsible investing, or SRI. Not too many years ago, SRI was an eccentricity. Now, it's an industry. The Social Investment Forum, in its latest report (December 2003), says that $2.2 trillion has been invested in SRI portfolios managed by professionals -- up from just $40 billion in 1984. There are 200 mutual funds that focus on stocks that meet ethical criteria. Many are tiny, but 26 have more than $100 million in assets and four have more than $1 billion.

The largest is Ariel (ARGFX), with $4.2 billion. Specializing in small-cap stocks, the fund has been managed by its founder, John Rogers, since 1986 and has compiled a superb long-term record, with average annual returns of 16.2 percent over the 10 years ending Jan. 26, 2005 [update]. That's more than four points ahead of the benchmark Standard & Poor's 500-Stock Index and easily surpasses the Russell 2000 small-cap average.

In general, SRI funds perform about the same as the broader market. For example, the Domini Social Equity Fund (DSEFX), based on the Domini 400 Social Index, the equivalent of the S&P 500 in the SRI world, returned an annual average of 3.3 percent for the past three years. Vanguard Index 500 (VFINX), the most popular S&P index fund, returned 2.8 percent. Over five years, the SRI index fund lost an average of 3.7 percent while the S&P fund lost 2.1 percent.

In other words, you can have your socially responsible cake and eat it too. There's no need to sacrifice bucks to satisfy conscience. There are two caveats, however. First, SRI still does not draw the best and the brightest portfolio managers; choices are fairly limited, and you are unlikely to find many sparkling funds. Second, good corporate citizenship won't boost a company's profits or a stock's price.

A recent study by Arthur Laffer and two other economists, in fact, recently concluded that there is "no significant positive correlation" between corporate social responsibility and profitability." An SRI pioneer, Jerome Dodson, a former foreign service officer who founded the Parnassus Fund (PARNX) 20 years ago, admits, "Although social criteria do not help a fund's performance, they also do not constitute a barrier to attractive financial returns."

The best way to understand SRI is to look closely at the Domini 400, the lodestar for ethical investors. Launched in 1990, it is maintained by KLD & Co., a firm started when Amy Domini, then a stockbroker, noticed, as her website puts it, "that some of her clients weren't happy to invest in certain companies, such as large defense contractors and tobacco companies, whose policies they disagreed with."

The index, indeed, excludes from its portfolio tobacco companies and defense contractors - as well as firms involved in gambling, alcohol and nuclear power. Domini takes no prisoners. In 2000, the index dropped Marriott International because it added casinos to some of its hotels. In 1999, it dropped Hasbro because, as KLD explained, "the company...licensed its brand name 'Monopoly' for use by a slot machine company." KLD won't list any company that derives more than just 2 percent of its revenues from the manufacture of military weapons or even products that have both civilian and military uses. Alcoa, the aluminum manufacturer was dropped in 2000 acquired a much smaller firm with military contracts.

Also nixed are businesses that make chemical fertilizers, which KLD considers dangerous to the environment, as well as firms with poor labor relations. Most SRI funds use a similar screening technique, in many cases preemptively excluding precisely the same categories.

In choosing its 400 stocks, the managers of the Domini Index give credit to companies with "more enlightened policies and practices ranging from the diversity of their boards, to the way they treat their employees, to their environmental performance."

The result is an index which, when compared with the S&P 500, has striking similarities and striking differences. For example, 13 of the 25 largest S&P stocks are also among top 25 holdings of Domini (as of September 2004, the latest Domini report). But excluded from Domini entirely are five of the six biggest S&P companies by market capitalization - or stock value.

The five are General Electric, ExxonMobil, Pfizer, Citigroup and Wal-Mart Stores. Microsoft, the S&P's third-largest stock, is Domini's top holding. In fact, most tech companies -- except IBM, which was booted in 1998 for selling supercomputers to a Russian weapons facility -- are widely admired, both by KLD and other SRI firms. Intel, Cisco, Dell, SBC and Verizon are also among Domini's top 15 holdings, which makes you wonder whether the index (plus its related fund) isn't a bit overloaded in high-tech and telecom.

But, more important, do you really want to own a large-cap mutual fund that lacks the America's largest retailer, bank, pharmaceutical company and energy firm? I myself would not, but you can't argue with performance.

Still, you can argue with the notion of turning over responsibility for moral decisions -- highly personal choices -- to a mutual fund manager.

I think that making weapons is a highly ethical pursuit -- since those weapons are generally used to defend the United States (a good thing) and to help spread liberty and even democracy abroad (also good). Nuclear power, in my view, is something we need more of, and I think Wal-Mart, by driving down prices consumers pay, has been a force for good.

I am not enamored of companies that produce music with misogynist lyrics or firms that collude with the government to pass laws that increase regulations with the express intent of hurting competitors or that boost protectionism.

Others may differ. But what if you think gambling and weapons are fine, and alcohol and nuclear power aren't? Sorry, but there's no fund for you.

This is not to say that all SRI funds are alike. Ariel's top holding is a casino stock, Caesar's Entertainment (CZR), and the fund also owns the allegedly evil Hasbro. Calvert Group, another large SRI specialist, maintains its own index, which, unlike Domini's, includes IBM but excludes American International Group (AIG), the world's largest insurer, because it "no longer meets Calvert's criteria for business practices." AIG, at last report, was the number-two holding of Domini's index fund.

Then, there's the Noah Fund (NOAHX), which says it picks stocks "based on Biblical principles." Unfortunately, its performance has been pretty miserable, and it charges a 5.5 percent load and 2.2 percent in annual expenses.

The firm that Roy Neuberger started offers one of the oldest SRI funds. Neuberger Berman Socially Responsive (NBSRX), launched in 1972, is less dogmatic than most. It leans toward health care stocks and even owns one of those dreaded integrated oil companies that Domini eschews. Its top three holdings are Liberty Media (L), Canadian National Railway (CNI) and UnitedHealth Group (UNH). The track record is impressive - average annual returns of 4.9 percent in the tough market of the past five years, relatively low risk, and a five-star (tops) rating from Morningstar.

In addition, the fund's annual expense ratio is just 1.1 percent. Domini Social Equity charges 1 percent, which is outrageously high for an index fund. Calvert Social Index A (CSXAX charges 0.8 percent, plus a front-end load of 4.75 percent! How socially responsible is that? You can buy an S&P index funds that charge less than 0.2 percent).

Neuberger Berman is my top SRI pick among large-caps and Ariel among small-caps. But, in the end, I would much rather do the ethical triage myself, thank you.

A version of this first appeared in Kiplinger's.


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