SRI funds share market gloom

Socially responsible bond funds may have managed to end 2002 in positive territory, but some of their equity equivalents at least outperformed their benchmarks. Melanie Goodfellow looks at last year’s SRI winners and losers

After another lousy year for the financial markets, the performance of socially responsible investment (SRI) funds provided their advocates with little evidence of outperformance – nor their critics with much proof of the opposite.

In the US, the Dow Jones Industrial Average and the S&P 500 fell 15.04% and 22.10% respectively, marking their first three-year decline since World War Two. The MSCI Europe dropped 25.96%, while the Nikkei 225 slumped 18.76%.

Against this difficult backdrop, SRI funds put in a mixed performance, generally delivering returns in line with their more traditional counterparts.

“Our findings for the last year were that the subset of SRI funds largely tracked the broader universe of funds,” says Shannon Zimmerman, fund analyst with Chicago-based investment research firm Morningstar. “Once you get past all the social screenings, the same forces that impact non-SRI funds impact SRI funds. Last year, the most successful SRI funds were the ones which invested primarily in fixed income.”

Shannon Zimmerman, Morningstar: "SRI funds largely tracked the broader universe of funds

That said, although fixed income funds topped the one-year return charts, most underperformed their benchmarks. Equity-based SRI funds, on the other hand, nearly all posted negative returns but in a number of cases outperformed their benchmarks.

Top US performer in terms of one-year returns, according to a table compiled for Environmental Finance by Standard & Poor’s Micropal unit, was the $53 million Capstone Social Ethics and Religious Values Bond Fund.

But its performance had nothing to do with the financial wizardry of its manager. It is a passive fund based on a screened version of the Lehman Brothers Government/Credit (LBG/C) Index consisting of US Treasury and Agency bonds as well as investment grade corporate obligations.

“We take an index – the S&P 500 or the Lehman Brothers Government/Credit, for example – take off the bottom and eliminate those that have links with alcohol, caffeine-based beverages, gambling, meat packing, pornography or tobacco companies,” explains Robin Patout, a spokeswoman for the Houston-based company.

Boosted by the rally in US Treasuries (which many SRI funds avoid on principle), Class ‘A’ shares of Capstone’s Bond Fund delivered annual returns of 10.37% but underperformed its benchmark, the LBG/C Index, which rose 11.04%. Capstone’s only managed fund, the Capstone Growth Fund, an equity-based fund aimed at long-term appreciation, posted a one-year return of –24.1% in 2002.

The altogether more socially-engaged Domini Social Bond Fund, which held assets of some $32 million by the end of the year, delivered a one-year return of 8.51%. Managed by New York-based Domini Social Investments (DSI), the fund benefited from the fact that 50% of its portfolio was made up of US mortgage-backed securities, which generated better yields than Treasuries in 2002.

“The fund’s future performance is down to what happens with interest rates. Because most of our paper is issued by government-backed agencies, we don’t really have a problem with credit ratings. I think the fundamentals are in place for the economy to start heating up again but unfortunately the psychology isn’t,” comments DSI founder and head Amy Domini.

The Domini Social Equity Fund, the assets of which topped $1 billion at the end of the year, posted a one-year return of –20.69%.

“The situation was more positive than two years ago when George W Bush first took up office. There was a mad rush into chemicals, oil, weapons and nuclear power – all the industries that had been under pressure under the previous administration. In that market environment, I was in a terrible position,” she says.

Fixed income funds focused on corporate debt had a roller-coaster year, falling on a wave of credit downgrades in the wake of the Enron and WorldCom collapses. Class ‘A’ shares of the $167 million Calvert Social Investment Bond Fund, made up of corporate bonds, returned just 6.15%, underperforming both its benchmarks, the Lipper ‘A’ Rated Bonds Funds Average (8.57%) and the Lehman Brothers Aggregate Bond Index (8.25%).

“Our bond portfolio doesn’t buy Treasuries, which are a big component of many indices. So while Treasuries had a final return of around 12%,we don’t own any,” says Calvert’s chief financial officer Reno Martini. “Added to this, we own a lot of corporate debt. In 2002, corporate bonds experienced the most severe round of downgrades ever.”

Conversely, Class ‘A’ shares of Calvert’s $517 million Social Investment Equity Fund, managed by Atlanta Capital, posted a one-year return of –14.93% but far outperformed the S&P 500, as well as the Lipper Multi-Cap Core Funds Average (–21.74%) against which it is also benchmarked.The fund, which focuses on mid- to large-cap stocks, has outperformed the S&P 500 for the last three years. “The fund’s success is all down to stock selection,” says Martini.

Other large-cap funds with a blue-chip bias whose one-year returns beat their benchmarks included the Neuberger Berman Socially Responsive (–14.45%),Walden Social Equity (–12.95%) and Women’s Equity Mutual (–14.59%).

At the bottom of Micropal’s US table, meanwhile, was the $21 million Citizens Value Fund. It posted returns of –46.22%. Formerly known as the Meyers Pride Value Fund after its creator Shelley Meyers, Citizens Funds bought the fund in 2001, taking full control in October 2002. Meyer’s specialty had been finding companies with stock prices below their intrinsic value.

“Its performance has been quite erratic,” comments Morningstar’s Zimmerman. “The former manager’s preference was for beaten down stocks.Over the last three years, stocks that got beaten down tended to get beaten down even more, so having a preference for the market’s unloved hasn’t been a winning strategy. Having said that, it remains to be seen how that plays out because a lot of really strong names got cheap.”

In Europe, the Micropal table painted a slightly different picture. Once again, fixed income funds dominated the top of the chart but underperformed against their benchmarks. Equity funds, however, fared far worse than their larger, Transatlantic equivalents, commonly giving one-year negative returns in the –30% to –40% range.

The top performing European fund, according to Micropal, was the Raiffeisen Futura Swiss Franc Bond Fund – a fixed income fund aimed mainly at Swiss institutional investors with assets of roughly Sfr95 million ($70 million), managed on behalf of the Swiss Raiffeisen Bank by the Swiss arm of German Vontobel Fond Services.

Made up of bonds and other Swiss franc-denominated fixed or floating rate instruments, screened by INrate in Zurich, the fund returned 7.17% in 2002 but underperformed its benchmark, the Swiss Bond Index (SBI), which rose 10.22%.

“This benchmark doesn’t reflect the fund’s investment universe, however, as approximately 30% of the bonds in the SBI are issued by the Swiss government which does not qualify for the fund’s investments because of its military concerns,” comments fund manager Juerg Bretscher.

The Raiffeisen Futura Swiss Bond Fund was the only one of the Swiss bank’s SRI funds to stay in positive territory. Its Global Bond fund registered a small loss, while its Swiss and Global Stock funds fell 36.05% and 29.69% respectively.

The next best performer was Italian bank Sanpaolo IMI’s Sanpaolo Obbligazionario Etico Fund, returning 6.62%. Roughly 50% of the €425 million ($394 million) fund is invested in European government bonds, 30% in corporate bonds and 20% in paper issued by supranationals such as the European Investment Bank, the African Development Bank and the Brazilian development bank BNDES.

“The fact we were heavy in government paper was an advantage.We suffered with our Brazilian position due to concerns over the future of Lula da Silva [the country’s new president, who took office in January],” says fund manager Andrea de Nardis. “The situation has since stabilised and our investment is back on track. On the corporate side, we’ve tended to go for investment-grade companies such as Rabobank, ING,Vodafone and Telecom Italia, which has resulted in fairly good results.”

A pioneer of SRI in Italy, Sanpaolo IMI’s other SRI funds fared less well. Its global equity fund Sanpaolo Azionario Internazionale Etico posted a one-year return of –30.78% while the global Sanpaolo Obbligazionario Estero Etico posted a one-year return of just 0.66%.

French SRI fund Nord-Sud Developpement, which is the top performer over three years, came fifth in terms of one-year returns, delivering 2.66%. Roughly 75% of the fund is made up of high-quality paper issued by supranationals specialising in development. Up to 8% is invested in developing world micro-credit programmes.This type of investment can take time to set up so the resulting liquidity is often invested in sovereign debt issued by emerging market countries.

In the first half of 2002, fund manager Claire Bourgeois pulled out of short-term yen positions and moved heavily into short-term paper issued by US and European supranationals to take advantage of expected interest rate falls on both continents.

“Aside from this, we invested quite heavily in emerging market sovereign debt at the beginning of the year.At the end of March we noticed the returns were weakening so we pulled out. Then at the beginning of August, when the IMF announced its economic plan for Brazil,we went back into emerging market sovereign debt,” explains Bourgeois.

The worst performing European fund in the Micropal universe, meanwhile, was Frankfurt-based DG-Capital Management’s KD Fonds Oeko-Invest. Having invested heavily in renewable energy companies, the fund experienced a disastrous year in 2002, posting returns of –49.19%. Its assets, meanwhile, shrank from €30 million in the middle of 2002 to €14 million at the beginning of this year.

“The renewable energy sectors of wind energy and solar energy and water treatment accounted for 30% of the fund’s portfolio. Some of the stocks we’d invested in lost between 70% and 90% of their value,” says fund manager Harald Bareit. “We kicked out a bunch of failing investments and switched into blue chip stocks like Pfizer and Disney but these were also having a rough time.”

He and his fellow manager Frank Kemper have since set about restructuring the fund more radically.They have dropped a handful of their renewable energy stocks and reduced big positions in a number of others such as water company Wedeco and wind turbine manufacturer Vestas.

“We still believe in the technological and renewable companies we still deal with but we have reduced our exposure. At the moment, renewable energy stocks account for roughly 25% of the portfolio and I think this will be the ceiling for the time being,” concludes Bareit.

Asia’s fledgling SRI market, meanwhile, experienced a fairly abysmal year. In Australia, where most funds are equity-based, AMP Henderson’s Sustainable Future Australian Share Fund came out top with one-year returns of 3.15%. The company’s Sustainable Future International Share Fund came fourth, delivering one-year returns of just 0.96%.

Japanese SRI funds weathered yet another difficult year. Only one SRI fund – Mitsui’s Eco Balance fund – stayed in positive territory with a one-year return of 1.12%. Nikko Asset Management’s Nikko Eco Fund, the country’s biggest SRI fund, posted one-year returns of –19.93% in 2002, against –23.97% in 2001. Total assets stood at ¥40.9 billion ($346 million) at the end of 2002 against ¥64.7 billion at the end of 2001.

Drawing its stocks from the Japanese Topix Index, the fund reduced its positions in banks and financial services companies to concentrate on chemicals and electronics.The fund is planning to go overweight in electronics in 2003 on the expectation of a small upturn in that sector over the year.