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Investing In Your Values

By: Frank Armstrong

By: Frank Armstrong, CFP, AIFA

I’m very sympathetic to folks who would like to invest in their values. But, I’m not sure how to turn that into anything close to an optimal investment policy.

There are a number of faith-based values based mutual funds which were profiled in The Wall Street Journal on March 20, 2007, “Putting Faith in Mutual Funds, Religious Investing Sometimes Offers Saintly Returns” By Rob Wherry. Morningstar lists more than 50, collectively managing more than $17 billion.

Faith based funds are not the only funds attempting to invest with their values. There are additionally funds that invest using pacifist, “green”, woman owned, minority owned, or other social screens. They all face the same difficulties in creating a prudent investment portfolio.

Morningstar is, of course, quick to point out that a few of the faith based funds have beaten the S&P 500 index. Of course in any universe of 50 funds, some will certainly beat the index. Predicting in advance which funds that might be is the central problem that Morningstar has never been able to address in any of their commentary. Furthermore, for the last seven years the S&P 500 index has been one of the most disappointing places in the world to invest. So, that’s a pretty low hurdle to clear.

Across the entire group of social funds the results have been reasonably dismal. Anyone with a properly diversified global portfolio should have done better. Chasing past performance of the successful funds is unlikely to be any more fruitful than any other strategy chasing past performance. So the facts hardly support a social investing policy as a path to higher returns.

It’s our belief that an optimum portfolio will be diversified across many of the world’s markets. But many of the more attractive markets have no socially responsible funds investing in them. For instance, I’m unaware of any funds investing in real estate, foreign small value, emerging markets small, or commodities. This leaves the investor in an uncomfortable position. Either he accepts a poorly diversified portfolio, or his investment policy will be 10% responsible. Investors who are attracted to the idea of socially responsible investing will hardly be turned on by being 10% responsible.

The vast majority of socially responsible funds are actively managed. This introduces the same problems experienced by any actively managed fund: high-cost, high turnover and an additional layer of management risk. For instance, the Ava Maria Growth Fund (Profiled by the Journal in their article) has a 1% surrender charge and an annual expense ratio of 1.5%, comparing unfavorably with Vanguard’s S&P 500 with no surrender charge and a 0.18% expense ratio. It’s going to be hard to overcome a 1.32% annual additional expense drag over the long haul.

And then there’s the problem of deciding who is to make value judgments. One church may be sensitive to issues of birth control but not alcohol, while another church would have totally different values.

How strict will we be in applying our standards? Some funds will invest in companies that have lines of business which they find objectionable as long as not more than 50% of their profits derived from those businesses. Other funds will tolerate no deviation from their standards at all. One fund refuses to invest in hotel chains that provide adult entertainment via cable or satellite, leaving them with a significant industry totally absent from their holdings.

It’s relatively easy to screen out companies that produce liquor and alcohol, but other companies present difficult dilemmas. For instance, few companies have product lines that cannot be found on military bases. Should we exclude IBM and Coca-Cola on that basis? Large companies have multiple product lines and numerous distribution channels. The more we look at them the harder it is to find a company that doesn’t have a product or customer which offends nobody.

Few investors will find a fund that totally embraces their particular set of values. While the Ava Maria Growth fund will not invest in any company that violates Catholic Values, they are silent on the questions of gun control, alcohol, tobacco and gambling. Many Catholics have legitimate concerns about these issues as well.

Looking at the problem from another perspective it’s hard to punish a company by refusing to hold their stock. All stock is owned by someone, and if you refuse to purchase it someone else will. The stock doesn’t exist in a vacuum. Someone owns every single share. Perversely if enough people sell their stock in an offending company they may drive the price of the stock down. Those willing to purchase it will get better prices and expect higher returns. The net economic impact on their selection process will either be severely limited or close to zero.

Fiduciaries of religious and charitable institutions have a difficult dilemma. Their membership and boards may have strong moral beliefs and values. They are allowed to pursue socially conscious investing under fiduciary guidelines like the new Uniform Code, but they’re given precious little guidance as to how they might do it successfully. To pursue socially conscious investing they must accept a portfolio that is higher cost and higher risk. That portfolio is highly unlikely to perform better than a properly diversified passive asset allocation portfolio chosen without restraint. If they are willing to accept the portfolio that is higher risk, higher cost, and lower performance, they impair the institutions mission. What activities and funding are they willing to give up? What additional risk of portfolio failure are they willing to bear?

By comparison a globally diversified index fund investment policy is at worst morally neutral. However the lower costs lower risk and enhance return possibilities provide opportunity for the institution or individual to fund additional social goals. (I would ague that supplying capital to the world’s economy is a morally positive thing.)

At the beginning of this article I admitted that I’m entirely sympathetic with people and institutions that feel they should influence social policy through their investment choices. I just don’t know how to implement that policy as an investment advisor. My grandfather was murdered by cigarette companies. That’s an intensely personal issue for me. Watching someone you love die from emphysema is a brutal experience. Yet purging cigarette companies from my portfolio is unlikely to punish them and will be far more trouble than it’s worth. Education, legislation, and court actions are far more likely to be effective. If that fails, I can only hope they will be punished by a higher power.