Diane Keefe of Pax World High-Yield Fund

S&P Rank: Not Ranked Higher Calling for High-Y

Quick Take: The Pax World High-Yield Fund (PAXHX) is the first so-called socially responsible junk bond fund to be offered to the general public, according to Pax World funds.

The fund does not invest in companies involved in gambling, alcohol, tobacco, or weapons manufacturing. It also shuns those that hurt the environment.

Portfolio manager Diane Keefe said she proposed starting the fund because she wanted to show that it could perform as well as similar funds that don't use social screens. "I think we've done a pretty good job in proving that over the last two years," she said.

The fund's performance bears that out. Pax World High Yield was down 5.8% for the year ended in July, but that put it ahead of its low-quality bond funds peers, which were off 6.8%. The fund returned 5.7% last year, while its peers rose 1.6%.

The fund, which was started in late 1999, is too new to be ranked by Standard & Poor's.

The Full Interview:

Sometimes the social screens that Diane Keefe uses have helped her sidestep problem companies.

For example, she excluded Tyco Intl (TYC) from the Pax World High-Yield Fund because the conglomerate does business with the military. Tyco's bonds were downgraded in May and again in June, and their rating could be lowered again.

But the filters don't always separate out bad apples, as Keefe's investment in Adelphia Communications Corp. earlier this year shows.

The cable company originally made its way into the Pax World High-Yield Fund because the business looked attractive, Keefe said. But she sold its notes in June, at what she termed a "huge loss," following a series of abuses at the company.

Three members of the Rigas family, Adelphia's founders, resigned from the board in May amid allegations that the company inflated earnings, and questions about its bookkeeping. Subsequently, John Rigas, Adelphia's chief executive, and his two sons were were arrested last month on charges of using corporate funds for personal use.

Keefe is participating in a class action lawsuit against Adelphia's former auditor, Deloitte & Touche.

While investing along socially and environmentally friendly lines, or examining corporate governance, won't uncover criminal acts, it can still play a role in managing money, Keefe believes.

"The general morality of how somebody behaves in business is important," she said. "We tend to think that people who are antagonistic towards the labor unions and their employees generally are going to have more strife associated with their day-to-day operations than people who have more of a collaborative approach."

The fund, Keefe noted, avoids companies that have histories of bad labor relations, or that lack a diverse workforce.

Management's conduct can also be reflected in the composition of a company's board, according to Keefe, who feels a diverse group of directors can be more independent than a homogenous one.

After identifying companies that meet the fund's social requirements, Keefe looks for those with large market share and strong and improving cash flow and margins.

The fund's yield, currently about 7.5%, is lower than its peers, Keefe said, because the portfolio tends to be more defensive than similar funds. She won't chase a high-yielding debt security if she thinks its risks outweigh its potential rewards.

Bonds rated B now account for about two-thirds of the portfolio, while 26% is given over to those rated BB, and 6% to BBB-rated bonds, Keefe said. A handful of holdings are rated CCC.

Keefe and the two analysts she works with try to find bonds they think should be graded higher than they are by ratings agencies. "We try to identify a single-B that looks to us like a double-B, and so on," she said.

The fund itself, she said, wants to attract investors who are seeking "incremental" higher yield and portfolio diversity by buying junk bonds, but who are risk averse.

"Our strategy is: in the good years, we should achieve double-digit returns," Keefe says. "And in the bad years, we limit the losses."

Pax World High Yield, which began operating in October 1999, currently has about $18.5 million in assets, and has been taking in money despite the recent weakness in the stock and high-yield markets, according to Keefe. The manager added the fund has had no "significant" outflows of cash.

Keefe bases her investment decisions in part on her view of how the economy will perform. Right now, she thinks growth will be sluggish in the near term. However, she thinks consumer spending will improve. As a result, about 48% of the fund's assets are in companies that provide products or services to consumers.

Bonds of health care companies make up about 17% of the portfolio, said Keefe, who envisions these companies benefitting as the U.S. population ages and needs more drugs and medical services.

The types of companies the fund invests in is also tied to Pax World Funds' mandate to find those that offer something that improves the quality of life, Keefe said.

"We've tried to buy the things that don't really go up and down that much," she said

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