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Staying Balanced

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The germ of the socially responsible investing (SRI) movement sprouted from a letter that Luther Tyson and Jack Corbett, who worked on peace, housing, and employment issues for a national board of the United Methodist Church, received in 1967 from a woman in Ohio who wanted to invest her pension money without supporting war-related industries. Four years later they teamed up with Paul and Anthony Brown and launched Pax World Fund, the first mutual fund to use social as well as financial criteria in making its investment decisions, with $101,000 in assets.

Since that time, the original SRI fund has broadened its name to the Pax World Balanced Fund (PAXWX), its assets under management have climbed to more than $1.5 billion, and it’s been joined by more than 175 other funds that use social, moral, or environmental screens in their investment process.

The current portfolio manager, Chris Brown, has held that position since 1998 and is the son of the original manager, Anthony Brown. “You do not have to sacrifice performance to be a socially responsible investor, and I believe our fund has proved that over the long haul,” he says. “People throw money at you for so long, but if you’re not performing, it comes right back out.” Over the last decade, new money has continued to flow into the fund, which first topped $500 million in assets in 1996 and $1 billion in 1999.

When it comes to performance, objective observers find a lot of positives in the fund. Morningstar gives it an overall ranking of four stars, a rating echoed by S&P, which also gives it a performance ranking of 62 out of 1,405 asset allocation funds for the most recent one-year period and 26 out of 285 for the 10 years. Last year it was the highest-ranking SRI fund tracked by with a 13.39% return. Its low turnover rate (19.33% vs. 70.53% for its peers, according to S&P), zero front-end load, and 0.5% management fee have kept expenses to a minimum, further contributing to its strong returns and its appeal to advisors and investors.

To start off, why don’t you tell me about the investment philosophy behind the fund. Because we are a balanced fund and we are asset allocating, our process is primarily top down. We’re looking at domestic and international economies. We can invest up to 25% of the fund’s assets overseas. We’re also looking at the interest rate environment and equity valuations. Then we decide on an asset allocation between stocks, bonds, and cash and equivalents. Our stock selection is pretty much theme- or sector-driven. We focus the portfolio on sectors we believe will outperform or outpace the overall rate of GDP growth. Our stock selection is basically GARP–primarily large-cap growth companies that are industry leaders with strong management, strong balance sheets, and consistent earnings.

What sectors are you hot on at this point? Right now the areas we’re excited about are energy, like everyone else, and materials. They both helped us outperform last year and they continue to help us out this year. Another theme we’re focusing on is water and how having potable water supplies is becoming more and more of an issue globally. So we’ve been focusing some of the fund’s attention on companies that could possibly participate in that, but energy and materials are probably our biggest focus right now.

What you’ve said so far addresses the balanced nature of the fund, but how does social responsibility factor into your screening process? We’re looking for companies that provide products and services that enhance the quality of life. We’re looking at fair employment policies and practices with regard to women, minorities, and people with disabilities. We also look at a company’s environmental policies and pollution control, and we avoid companies that are involved in the manufacture of weapons and related products; we avoid tobacco, liquor, and the gambling industries.

We’ve built up a universe of companies that pass our screens. We have an internal screening department that takes care of that and regardless of whether we are interested in buying the company today or in a few months, we constantly screen companies just so we have them in our database. When we decide to act we can do so without hesitation. I like to emphasize that looking at a company from two different perspectives– not just the financial, but the social as well–really adds value to the investment process. We have an in-depth understanding of that company because we are looking at it from two different perspectives. That’s translated into competitive returns with respect to other SRI funds and other balanced funds.

Your decision to sell off your Starbucks stock was in the news recently. Would you comment on that? It has agreed to license its coffee and name to Jim Beam [for a coffee liqueur]. That violated our screens because one of our screens is no alcohol. So we unfortunately had to sell the stock, although they’ve got a lot of other good things going for them.

They’ve been great on fair trade, where they pay growers a fair price for their coffee, and they’ve been in the forefront of recycling. We really like the company, there’s not much competition, there’s not another large coffee company, except for Dunkin’ Donuts which is owned by a much larger company. [Starbucks has] some really strong programs, but unfortunately because of the alcohol exposure we had to divest ourselves. Even prior to that, the valuation was getting a little frothy, for lack of a better word. The reason we had to get out was because of the alcohol, but we’re always looking at things financially, too, and who knows? We may have had to sell it anyway because we felt it was overvalued.

This was a stock that you had held for quite a while? I think our cost was like $7 on it, so we had quite a capital gain. We’ve owned it since, I believe, 1997. [Pax World Balanced Fund had held 375,000 shares of Starbucks stock, which was worth an estimated $23.4 million at the time the divestiture was announced.]

Do you have any particular plans for the proceeds from that sale? Actually, I’ve been buying another beverage company, Pepsi. So I’ve redeployed those assets into Pepsi. A lot of people think you’re really limited [by an SRI orientation], but there’s enough of a universe out there, enough really good companies that it’s really no problem, I feel, when we have to divest ourselves. Typically it’s pretty easy to find another company.

In terms of asset allocation, when you say 25% of your holdings can be overseas, is that strictly equities, or do you have other options as well? It could be foreign bonds. For example, we own some Vodafone bonds. But we also own Vodafone the common stock. But it’s 25% of total assets.

What kind of breakdown do you look for in your asset allocation? By prospectus we have to have a minimum of 25% in fixed income or bonds. I think right now we’re at 26.5%.

What kind of fixed income investments are you making these days and what kind of returns are you getting? Our duration is about 2.5, which is pretty low, so obviously we’re anticipating higher rates down the road. But one way we’re protecting from high rates is not just shorter duration but also looking at these inflation-protected-type securities that have a floating rate. They float up if the CPI is going up; the actual coupon can go up with it. We’ve also been purchasing some step-up bonds, which primarily do the same thing. But in terms of yields, historically we’re still at record lows, so it’s pretty tough to get a pretty decent yield. Instead of yield, I’m more concerned with preservation of capital in the fixed-income side.

Do you think there will be more pressure in that regard? I do. The GDP number came out and they revised it down to 3.8%, so bonds rallied, but I think the economy is in pretty decent shape and historically we’re at such a low end, even with some moderate growth in the economy, the Fed is going to have to stay ahead of this and continue to raise rates.

In terms of fixed income, how do you break down between corporate securities and government bonds? At the end of February, we had about 6% of assets that were corporate securities and about 20% that were government agencies or mortgage-backed securities. We focus on agencies and mortgage-backeds. We cannot invest the funds into Treasuries because they could be used for weapons. You don’t know where the money goes, so we’re investing in agencies that obviously support housing.

Would you care to talk about some of your larger equity holdings and why you found them attractive? Our largest is America Movil, which is the largest wireless company in Latin America. This has been a tremendous success story for us. We have 475,000 shares. It’s really cheap relative to the group. They have a profit/earnings/growth ratio of under 1, about 0.63, so they’re growing significantly faster than what their P/E multiple would suggest. We’ve had that for three or four years. The value of it has appreciated up to that position.

As I mentioned before, we’re focused on energy and our second largest holding, as of the end of February, is Apache, which is an independent exploration and production company. They have great exposure to the North American natural gas, which is one of the cleaner fuels to burn. This company has a P/E/G ratio of about 1.21 and the industry P/E/G is about 1.78, so we feel there’s good relative value there for this company.

You might think, “Well, you’re an SRI fund, how can you buy some of these energy companies?” These guys are ranked, like, number 51 on the 100 best corporate citizens in 2004. [Ed. Note: The list of best corporate citizens is published by Business Ethics magazine based on data provided by KLD Research & Analytics.] Also, the EPA ranks Apache’s facilities as some of the cleanest and best in the U.S.. It does pass our screens, obviously.

Do you hold a stake in any of the major oil companies? We own BP, which I would categorize as the best in class of the majors. This is quite an incredible company. Socially speaking, they’re one of the biggest players in solar and wind development. They’re basically a leader in corporate sustainability. They have a whole environmental report about what they’ve been doing.

Is Dell still a big holding? It was number eight at the end of February. We have 550,000 shares. We’ve had some dialogue with them socially about recycling. They seem to be making pretty good inroads into recycling computers, setting up dropoffs so people can bring in their old computers. Financially speaking, they’re really second to none in the PC-making space. They’ve just done an incredible job, taking away from Gateway and HP.

How often do you adjust the fund’s holdings? We’re looking at them every day. Socially we have to review it every six months. Obviously there are so many developments taking place, we’re looking at the portfolio every day. Typically meeting with management, we have 81 companies in the portfolio and I’m not going to fool you and say we can visit with management every single year. I don’t know too many outfits that can do that. But we try and meet with three or four companies every quarter.

What is happening with the SRI movement? Is it something that’s gaining traction with the general investing public? It’s still a very small area of the mutual fund industry, but some of the reports that I’ve seen show it’s probably one of the faster-growing issues in the mutual fund industry. Our growth has been certainly huge. We’re up to $1.52 billion, but I think performance certainly helps in that department. We have shareholders that could care less about SRI, but they come to us for the performance. It’s kind of tough to gauge exactly how much of that is SRI money, but generally speaking, I’d say we’re getting pretty good growth in the SRI part of it.

Your investment minimum is so much lower than most funds. Does that mean you have a lot of shareholders with very small stakes in the fund? It’s $250 and after that you can send in increments of $50. I believe we’ve got to be one of the lowest in the industry and we’ve always maintained that. That’s the way it was from day one in 1971 and it remains that way. We always show up on those lists of things you can use if you want to start your kids off on investing. I think we have almost 70,000 shareholders and I believe a lot of that is small investors. We have a lot of grass roots where people are not using a broker, they’ve read about us, they’ve downloaded a prospectus, and they sent in the money.

You’ve got low minimums and low expenses. What about turnover? If you stack it up, I believe we have significantly lower turnover than most other balanced funds. We strive to be long-term investors and I think that’s another selling feature of the fund.

Is there a ceiling to how big the fund can get? We’re large-cap investors and as I mentioned before, we’re investing in government agencies and large-cap corporate bonds, so in terms of how much money we can take in, I feel pretty comfortable that we have a lot more room to grow before that ever becomes an issue.

Where does this fund fit in the average investor’s portfolio? Someone who doesn’t want to perform allocation but wants a core holding, I think they would find our fund would meet their needs. I like to call it an all-weather fund. We’ve got the asset allocation going and we’re making that decision based on what we think is going on with the economy, and a lot of people don’t want to make those asset allocation decisions, let alone pick an individual stock. I think we’d be a core holding for people and it would be a moderate growth situation.

Staff editor Bob Keane can be reached at [email protected].


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