Socially responsible investing (SRI) is rising in popularity as investors seek to match portfolio assets with personal beliefs and values. One of the largest and most successful SRI funds, the $900-million New Covenant Growth Fund (NCGFX), invests according to the principles of its affiliate, the Presbyterian Church (U.S.A.) Foundation. The portfolio automatically excludes companies with significant operations related to alcohol, tobacco, gambling and firearms.

In short, good morals have been translating into good returns. For the one-year period through the end of August, the fund gained 17.1%, versus a gain of 12.6% for the S&P 500, its benchmark, and 12.9% for the average large-cap blend fund. For the three-year period, the fund registered an average annualized return of 12.5%, edging out a 12.0% gain for the index, and 10.6% rise for its large-cap bend fund peers. Over five years, the fund dropped 2.0%, while the index slid 2.7%, and its peers fell 2.5%.

“We are the only SRI fund directly sponsored by a church,” notes Robert Leech, chief executive officer of the Foundation and president of New Covenant Funds. Based in Jeffersonville, Indiana, New Covenant supervises five independent subadvisers — Wellington Management Co. L.P., Mazama Capital Management Inc., Santa Barbara Asset Management Inc., Sound Shore Management Inc., and Capital Guardian Trust Co. — who perform security selection. The subadvisers each focus on a particular asset class or investment style, which helps to diversify the portfolio while controlling risk.

To start, New Covenant, a subsidiary of the Presbyterian Foundation, annually draws up a “divestment list” of companies that violate the church’s criteria for social responsibility. This list is handed over to the five subadvisers, and the companies on it are banned from the portfolio. Afterwards, each subadviser is free to invest in any other stocks that agree with their respective investment-style mandate. The subadvisers operate autonomously, and have final say in buy and sell decisions, subject to the screen of prohibited companies.

The subadvisers are allocated a portion of the fund’s assets. The bulk of the assets, 61%, are made up of style-neutral, multi-cap core investments run by Wellington. Three “satellite” allocations, each consisting of 13% of the fund’s total assets, are managed as follows: mid- and large-cap value stocks (Sound Shore); growth stocks (9% allocated to large-cap specialist Santa Barbara, 4% to small- and mid-cap specialist Mazama); and international stocks (Capital Guardian). Based on this breakdown, the fund is diversified by market cap size — 66% in large-cap stocks (above $10 billion), 30% in mid-cap stocks (between $1 and $10 billion) and 4% in small-cap stocks (under $1 billion).

“These target allocations may change periodically, but not dramatically,” notes George Rue, senior vice president of investments for New Covenant Trust Co. “When a certain investment style is hot, we could let the manager go slightly above their target allocation for a while before we rebalance the fund again to its initial level. In the past, the style-neutral core has represented as much as 65%-66% of the fund’s assets. But the basic structure has not really changed too much.” The fund recently increased its foreign stock allocation, instructing subadviser Capital Guardian to begin investing in the emerging markets.

Each subadviser was selected for performance, style bias, and investment process. Capital Guardian has been with fund since inception. Wellington and Sound Shore came in 2000, just after the fund’s inception. Mazama and Santa Barbara were hired in early 2005 to replace Seneca Capital Management, due primarily to poor performance and personnel changes.

The divestment list for the most recent fiscal year included 71 companies — both domestic and foreign — most of which were connected to either tobacco, alcohol, or gambling. Banned companies included such well-known firms as Boeing Co. (BA), General Dynamics Corp. (GD), Altria Group Inc. (MO), Anheuser-Busch Cos. (BUD) and Harrah`s Entertainment Inc. (HET). While New Covenant generally prohibits most stocks of defense and weapons-related companies from the fund, exceptions are sometimes made for those that do not manufacture land-mines or nuclear weapons, which kill innocent civilians.

“The primary concern of the church is the overall size of defense spending, foreign military sales, over-dependence on military contracts by a company, and weapons that do not distinguish between combatants and non-combatants,” Leech said. “Our list of prohibited defense stocks includes a combination of the top five military contractors, the top military contractors whose business is dependent on military contracts, the top five in foreign military sales, and those military contractors whose weapons don’t discriminate between soldiers and civilians (nuclear, chemical, biological, landmines).” He added that outside of this military divestment list, “our subadvisors are free to purchase any other defense-related companies.”

As of June 30, the fund’s top ten holdings were Citigroup Inc. (C), 1.8%; Exxon Mobil Corp. (XOM), 1.6%; Microsoft Corp. (MSFT), 1.6%; General Electric Co. (GE), 1.5%; Bank of America Corp. (BAC), 1.5%; Time Warner Inc. (TWX), 1.4%; Intel Corp. (INTC), 1.4%; Procter & Gamble Co. (PG), 1.2%; Pfizer Inc. (PFE), 1.2%; and CIGNA Corp. (CI), 1.1%. As of that date, the fund’s top sectors were financials (19.9%), information technology (17.7%), health care (17.3%), consumer discretionary (13.7%), and industrials (10.7%). The portfolio currently has 783 holdings. The large number is attributed to Wellington’s portion of the fund, since its multi-cap core position is benchmarked against the Russell 3000 index. “This ‘enhanced’ kind of index investing requires a large number of holdings,” Rue notes.

Beyond the investing restrictions, New Covenant monitors its holdings for compliance on social and political issues, including racial equality, environmental protection, labor relations, animal testing, pay disparity, and predatory lending, among others. Through proxy voting and shareholder advocacy, New Covenant may even seek to change the company’s policies.

The fund’s annual turnover typically falls between 60%-70%. The majority of sell transactions are based on investment fundamentals, rather than screen violations. Merger activity can also impact turnover. For example, Vishay Intertechnology Inc. (VSH), a diversified electronics firm which is banned by the fund due to its significant military contracts, acquired one of the fund’s holdings. That stock was quickly unloaded.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.