One of the things that I've come to realize about "conventional wisdom" is that while it's most certainly conventional, it often contains little wisdom. One of the most obvious examples is that just a year ago conventional wisdom indicated that this country just wasn't ready to elect an African American as President of the United States--maybe someday, but not yet. The fallacy of that argument became obvious on the evening of November 4, 2008.
Investment thinking is also beset by the tyranny of conventional wisdom. I'm particularly speaking of socially responsible investing and the idea that one automatically accepts lower returns as a consequence of doing the right thing. From what I've seen there's more and more research that shows that socially responsible investors do not pay a performance penalty, and in many cases enjoy returns in excess of the market averages. Yet there's still that conventional wisdom, as exhibited by an article I read at ConsumerReports.org, from November 2008 with the title: "Principles versus Performance," and the subhead, "Socially responsible funds let your conscience be your financial guide. But you might have to settle for lower investment returns."
"All of the fact-based research that I've seen has suggested that's a myth," counters Adam Strauss, one of the portfolio managers for the Appleseed Fund, which was named as Lipper's top returning mid-cap value fund for 2008 and as the top SRI fund by Morningstar.
Despite the accolades, 2008 was not the fund's best year. "We were down 18%, versus the market, which was down 37%," Strauss admits. "We didn't make money, but on the other hand we're happy that we were better able to preserve capital than most."
Strauss thinks that one of the reasons that perception about SRI investing persists is because investors following that strategy are much more passionate about the S and the R than they are about the I.
"Most socially responsible investors are very passionate about the issues and they're going to talk about the issues that are important to them," he observes. "To us, the issues are important, but generating strong long-term returns for our clients, and for our shareholders, is also very important, so we try to talk about both. I think that the socially responsible investment community has to do a better job of talking about both if socially responsible investing is going to become a more mainstream investing strategy than it is today."
Not Just SRI, but Value
Strauss stresses that while the Appleseed Fund undoubtedly subscribes to a SRI philosophy, it's also a value-oriented fund. It was launched in 2006 by Chicago-based Pekin Singer Strauss, which had been running a value-oriented separately managed account product since 1990.
"There's a lot of research that's shown over long periods of time that value investing significantly outperforms the market," notes Strauss. "There's also a lot of research that has shown that socially responsible investing outperforms the market. If you look, for example, at the Domini 400 Index, it's outperformed the S&P 500 Index since its inception. And we're focused not just on the one-year period, but on very long periods of time."
Although he says his firm wasn't aware of it at the time that it launched the Appleseed Fund, his own research has shown that the fund is somewhat of an anomaly in the SRI world due to its focus on value stocks.
"We discovered that less than 5% of all of the [SRI] mutual fund assets under management are classified as value and the rest are classified as core or growth, when across all mutual funds it's typically one-third/one-third/one-third. So there's a real under-representation and, among value funds, there's hardly any socially responsible funds."
While the fund itself is only a little more than two years old, Strauss says that the preparation process also took close to two years. During that time a rigorous screening process was developed, as were policies and procedures for pursuing community investing and shareholder advocacy issues.
"Promoting social and environmental responsibility has been a long-held passion of ours," Strauss explains, noting that with the firm's separate account clients, the approach is usually tailored to the specific client's social and investment goals.
"Our goal is create a portfolio that performs, obviously, but we also want our investors to sleep well at night, knowing that they're invested in socially responsible companies," he says. "So we use positive and negative screens in picking our investments. We use positive screens in the area of the environment, human rights issues, and community investing."
Currently the fund's largest holding is in John B. Sanfilippo & Son, (JBSS), owner of the Fisher Nuts brand. "From a social perspective, they represent a good value because of the products that they make. Nuts are an extremely high quality source of vegetarian protein. And researchers have found that people who eat nuts have a much lower rate of heart disease. On the other hand, nuts are a source of vegetarian protein and what that means is you can produce a pound of vegetarian protein with much less environmental impact than a pound of meat. The Center for a Livable Future at Johns Hopkins claims that producing one pound of feedlot beef requires 2,400 gallons of water and seven pounds of grain. That's much, much higher than what you get with nuts."
A Different Take on the Housing Issue
The community investing aspect of the fund's portfolio helped contribute to its strong relative performance last year, through the purchase of Community Reinvestment Act (CRA) qualified fixed-income securities and REITs specializing in both agency and non-agency mortgages.
"Our opinion is that the housing issue is not just an economic issue, it's a social issue, because when you have all kinds of foreclosures, it has a big impact on local communities. In our opinion, the best way to do this is to get mortgage rates down. We've been buying them because its our own little way of trying to contribute to lower interest rates."
Last year the fund was overweight in financials but because of the particular financial instruments it chose, the strategy paid off. "For most of 2008 we were primarily invested in agency mortgage REITs," says Strauss of the fund's financial exposure. "We thought there were good social reasons and we thought there was a good investment case to be made for these agency mortgage REITS because as agency mortgages they're insulated from credit risk and these companies make more money as the yield curve steepens. We expected that the economy was going to weaken significantly and that the Fed would reduce interest rates down to very low levels, which would reduce the borrowing costs of these REITs. And that's what happened. We were very reticent to get into a lot of overleveraged financials with very opaque balance sheets that have caught a lot of other value investors and socially responsible investors by surprise in 2008."
As far as changing the conventional wisdom regarding SRI, Strauss is pretty confident it will happen over time. "One of the great changes that we've seen in corporate America over the last 10 years or so is that more and more companies are taking proactive steps to make themselves more sustainable," he says. "I think part of it is a change in the investment community and part of it is a change in what companies are doing so that you can do positive screens and [find] positive things that companies are doing. We're looking for companies that are in the top half of their industry in terms of the proactive actions that they're taking to become greener companies."
As a greater number of investors take such metrics into consideration when buying stocks, SRI is bound to become more mainstream. In the meantime, it may not be conventional, but taking such factors into consideration certainly bears the hallmarks of wisdom.