From the August 2004 issue of Investment Advisor • Subscribe!

Doing the Right Thing

George Schwartz had already established himself as a savvy money manager with his Schwartz Value Fund (RCMFX) and had an impressive roster of private clients when a couple of well-known baseball fans who were clients approached him about starting a Catholic mutual fund. Although a practicing Catholic, at the time Schwartz wasn't quite sure what the term "Catholic mutual fund" meant, and he initially envisioned it as being limited to investments in companies that made rosary beads, built churches, or had some other overtly Catholic connection. The clients who approached him--Tom Monaghan, who founded Domino's Pizza and formerly owned Major League Baseball's Detroit Tigers, and former baseball Commissioner Bowie Kuhn--explained that what they had in mind wasn't quite that radical. Instead, they were interested in a mutual fund comprising the best stocks available but excluding those companies that made money from abortion or supported it in some way.

Thus was born the Ave Maria Catholic Values Fund. S&P gives the fund a four-star rating, while Morningstar just upgraded its rating to five stars. Since the fund's inception in May 2001, it has delivered an annualized return of 10.99%, outperforming both its mid-cap value style peers and its benchmarks --the S&P Mid-Cap 400/Barra Value Index and S&P 500 Composite.

Based on the success of this initial Catholic fund, last year Schwartz Investment Counsel launched two more--Ave Maria Catholic Growth Fund (AVEGX) and Ave Maria Bond Fund (AVEFX). The short-term performance of all three funds has helped to show that the combination of religiously derived moral values and sound investment principles can be a potent vehicle for those who choose to practice what they preach.

Could you tell me a little bit about how the Ave Maria Catholic Values Fund came into being? About four years ago, I was approached with the idea by some Catholic laymen, who were familiar with the Schwartz Value Fund and were clients with some of their personal investments. After I checked with the lawyers, and they said we could do that, we applied to the SEC. One thing led to another and we decided to put together a Catholic advisory board made up of six prominent lay Catholics. [In addition to Monaghan and Kuhn, members of the advisory board include Michael Novak, director of Social and Political Studies at the American Enterprise Institute, and Phyllis Schlafly, founder of the Eagle Forum.] They in turn solicited the advice of [Adam] Cardinal Maida, who is the archbishop of Detroit. Then that Catholic advisory board decided that rather than just screen out abortion, we should also screen out three other things--pornography, companies that contribute to Planned Parenthood, and any companies that provide their employees with non-marital partner benefits, whether same sex or different sex. The last one [arose] because the Catholic Church considers marriage a sacrament and the advisory board thinks that offering such benefits is a slap in the face to Catholics.

Using those parameters, we've screened out certain companies--about 400 from the Russell 3000. I want to emphasize I'm not a theologian. I'm not an expert on the Catholic Church. I happen to be Catholic, and a lot of the members of my staff are Catholic, but we're portfolio managers. We're investment professionals and we want to get the best possible investment results we can for our shareholders. We're all about getting the best investment results we can within the parameters established by the advisory board. To date, these screens have not inhibited us in any way or held us back in terms of investment performance.

According to the figures I've seen, the Ave Maria Catholic Values Fund is now at about $170 million in assets. How did that build so quickly? We've been very fortunate. We've had a big advertising promotion, mostly among Catholic newspapers and magazines. I've done a couple of television appearances to promote it. We've got investors in all 50 states. We've got 3,000 shareholders. And it's just gradually built.

How big is the average investment? If you do the math, the average investor has $56,000 in the fund. We've got some that are larger than that and we've got quite a few that are at the $1,000 or $2,000 level. We've also got 36 Catholic institutions now that have invested anywhere from $20,000 to several million dollars.

Are there different share classes? In the Ave Maria Catholic Values [Fund], there's only one share class and one expense ratio. So the institutions that are investing in the fund are willing to pay the same rate as anyone who puts in $1,000. Expenses are capped at 150 basis points.

Once you've gone through the screens, what are you looking for and how does your philosophy of investing come into play? We're always looking for bargains from an investment perspective. We're looking for, as [Warren] Buffett used to say, dollars for fifty cents. We apply our own investment screens to find undervalued stocks. Our forte is really in small- and mid-cap stocks; that's where the Schwartz Value Fund has been concentrated for 20 years.

We've got a lot of small- and mid-cap stocks in the Ave Maria Catholic Values Fund. We also have a mixture of large caps too, that give the portfolio a fair amount of balance. We've got companies like Exxon/Mobil, Genuine Parts, Harley Davidson, AIG, General Dynamics, and Automatic Data Processing. Some of those are pretty big companies, but they're all value in our view. They're all selling at low prices in relation to earnings, low prices in relation to cash flow, and--more importantly--at low prices in relation to future earnings and future cash flow. That's value.

Someone might say we shouldn't have bought Automatic Data Processing because that's a growth company. By our analysis, since we bought it when the stock was at 31, down from 65, it was a real value. Buffett always says that growth and value are just two sides of the same coin; depending on price, a so-called growth stock can be a value stock. I totally agree with that. We loaded up on Automatic Data Processing at 31 and 32 and the stock is at 45 today. Some consultant might say we're guilty of style drift, or that we're not sticking to our value approach. That's baloney. We'll decide what's value and the results will speak for themselves. We're trying to buy the best companies we can at the lowest possible price in relation to earnings and cash flow.

Everyone seems to define this fund differently. S&P says it's a large-cap blend, Morningstar says it's mid-cap value, which from what you say appears to be closest to your own vision. What does all that mean? This game of style boxes has gotten carried away. Someone pointed out that if Peter Lynch was managing the Ma-gellan Fund today, he would have been in all nine different style boxes over the course of his career, but that was because he just bought the best stocks he could find.

Have there been any stocks you've bought for the fund and then had to sell because they no longer fit within the established parameters? We had to sell some because some companies started practices that violated the religious screens. An example would be Kimberly-Clark. We bought Kimberly-Clark a while back and we liked it from a fundamental point of view. Then they started contributing to Planned Parenthood, which required us to sell the stock immediately. And we did. We then wrote a letter to the board of directors asking them to reverse their policy, which they ignored.

In the letter, we told them we thought it was a bad moral practice for a company to contribute to Planned Parenthood, but in their case it was a bad business practice as well. Kimberly-Clark makes Huggies diapers. Why would a company that makes diapers for babies want to contribute to Planned Parenthood? Ironically, after we sold it the stock dropped about 20%.

Another example is Eli Lilly. It had been the only major drug company that we could buy because all the other drug companies had involvement with abortifacients. We liked the stock, and then late last year it announced that effective January 1, 2004, it would start offering benefits to non-marital partners. We wrote a letter asking the company not to do so and saying we would have to sell the stock if it did. The company sent us a couple of letters saying that it had to [extend benefits] for competitive reasons: It wanted to hire certain employees--scientists and so forth--and to be competitive in the marketplace for these talented employees it had to offer these so-called "benefits." I always put that word benefits in quotation marks. Lilly said all its competitors were offering these benefits. We had already screened out all those other competitors because of their abortifacient involvement. January 1 it went into effect, and on January 2 we sold Eli Lilly.

How big a stake did you have in Lilly? We had a big stake. It was about $3 million worth, which at the time was about a 3% position in the portfolio.

I notice that you try to stay fully invested. What did you buy when you sold Lilly? We just rolled it into other investments. It may have been General Dynamics or SunGard or Maxwell Shoe. Those were the things we were buying at the time. It wasn't a specific stock that we bought as a substitution.

I'll give you another example that worked out pretty well. In the case of Harley Davidson we were erroneously told that Harley Davidson was providing non-marital-partner benefits. We bought Harley Davidson because it passed all of our screens and then it popped up on one of our screens as a company that had started offering non-marital partner benefits. So we called the company to verify that and we got a hold of somebody in their human relations department that said, yes, that's what we're doing now. So we sold the stock. Then we sent a letter to the board, as we always do, saying, "We wish you hadn't done that. Please consider changing your policy, because we'd like to buy the stock back. We think it's not morally correct and our shareholders don't want to be part of a company that offers these non-marital-partner benefits." We got a call a couple of weeks later from the head of the legal department at Harley Davidson. She said there had been a terrible misunderstanding. Harley Davidson did not offer non-marital-partner benefits, never had, and had no intention to do so. Whoever gave us that information was wrong. We asked her to send a letter to that effect, which she did, and we bought back the stock. We like Harley Davidson.

When I was appearing on "Wall Street Week," the host said that Harley Davidson doesn't seem like a Catholic company. They were thinking Hell's Angels and all, but that's the wrong image today. The company is a great American institution. It makes great products, and it's an absolute money machine.

The price was about the same when we bought it back, so there was no real big difference. Harley is one of our largest holdings now and I think it's an extraordinary company.

It seems that you've been pretty much shut out of the pharmaceutical business. Are there any other sectors where you aren't investing because nobody fits the religious screens? No. Pharmaceuticals are the big ones, but that doesn't mean we don't have healthcare stocks. We still have healthcare REITs and we have implement companies and an equipment sterilization company and several others related to healthcare in one way or another; they're just not making abortion-related medicines. We don't own hospital companies, either, that perform abortions or insurance companies that pay for abortions.

That must shut out a number of companies. It does, but they're not really companies we would want to buy anyway. AIG is a giant insurance company that does not violate any of the screens. I'm hoping it stays that way. I think AIG's a great company.

How often do you review your holdings? Constantly, although we're not buying or selling every day of the week. Some days we're selling stocks that are fully priced or nearly fully priced to redeploy the money into undervalued stocks. We're not traders. We're always buying stocks that we're planning on holding indefinitely.

One of the first stocks we bought in this portfolio was Craftmade [International]. It's still in the portfolio, and it's appreciated some 30-something percent since we bought it. Another stock we bought early on was Brookstone. That stock has more than tripled and we still hold it. It continues to grow at a 20%-25% rate and the stock, even though it's tripled, is not overpriced.

Do you personally have a big stake in this fund? Yes. I have a significant portion of my net worth tied up in our three Catholic funds. I'm a shareholder of all three funds and of the Schwartz Value Fund.

Staff Editor Robert F. Keane can be reached at bkeane@ia-mag.com.

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