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Friday, July 14, 2006

Are Donuts Unethical?

News summary by MFWire's editors

"Socially responsible" investment vehicles sound pretty irreproachable -- and TIAA-CREF on Thursday underscored this, publishing results of a survey showing that a considerable majority of its retirement plan participants prefer investments that reflect their social values. Yet how do you draw the line that determines what's socially negligent, and could funds be shooting themselves in the foot with too many restrictions?

A recent Bloomberg article illustrates how the demands of high moral standards can prove frustrating for portfolio managers. The Stewardship Growth Fund is the largest socially screened fund in the U.K., and has bested the FTSE over the past five years in spite of restrictions barring involvement with companies that deal in pornography, alcohol or tobacco. However, manager Ted Scott sometimes finds his range of options squeezed: the fund's screening team have decided Krispy Kreme is irresponsible for selling nothing but sugary pastries, while British Airways is adding to global warming.

A number of socially responsible funds have religious affiliations, and strict doctrine usually makes the list of no-nos clear. The Stewardship Growth fund, indeed, belongs to Friends Provident, an investment company based on Quaker values. But principles like pacifism and temperance can be interpreted in various ways, and Scott said he finds himself forbidden from putting money in about two-thirds of the U.K. market. As a financial advisor quoted by Bloomberg points out, ruling out asset classes can prevent a manager from taking full advantage of major market trends.

"From a purely investment perspective, you don't want to miss out," agrees Scott Budde, managing director in TIAA-CREF's asset management division. TIAA-CREF's Social Choice Equity Fund, through the services of Boston-based KLD Research and Analytics, uses both positive and negative screens to choose its investments. But Budde suggests KLD has come up with a better way to weigh up companies: as of July 1, it moved towards emphasizing a "best in class" approach.

"Rather than simply getting rid of all companies in a sector, they would look for companies that were doing particularly well," he said.

KLD's screening process for TIAA-CREF has two phases, Budde explained. First, the fund rules out all companies obtaining revenue from alcohol, tobacco, gambling, firearms, or military weaponry. Then they make a qualitative assessment, tackling "some of the more complicated or difficult or subjective issues ... there's a pretty long list. That gets into product usefulness, environmental issues, employee relations," he said.

One finding of the participant survey, he noted, was that investors favored an approach emphasizing positive rather than negative screening. The Stewardship Growth Fund's screening team has a blacklist that suggests how arguable negative screens can be. For example, the team leader said companies producing donuts in addition to healthier foods would not necessarily be ruled out, though all donuts presumably have comparable nutritional values. Aviation firms are off-limits because they are the "fastest-growing" producers of carbon dioxide, but a British Airways spokesperson said the company has improved fuel efficiency by 27 percent since 1990 -- and one could argue that, as a mass transport service, an airline is less irresponsible than an auto maker.

Budde agrees that banning whole industries is problematic. The best-in-class screen, in fact, creates an incentive for companies to improve their track records in terms of social responsibility. For example, a few years ago, Nike became the emblem of sweat shop abuses, but lately it's cleaned up its act. KLD responded by readmitting it. "You could easily criticize every major retailer for supply chain issues," Budde pointed out. "They saw a turnaround story of the company moving from being a laggard to being a leader."

The Social Choice Equity Fund also offers the tried-and-trusted elements of quantitative analysis and a recognized benchmark (the Russell 3000), notes Budde, adding that financial advisors tend to resist socially responsible vehicles because their investment process is unclear. Done right, screens are certainly no detriment, he believes.

"Our experience is that you can build a very, very competitive portfolio in terms of returns and risk with a wide range of screening ... we get performance that looks very, very similar to the Russell 3000, which is competitive performance in the world of equity management."

But he admits that touting the fund's screens as actively advantageous -- as Scott portrayed his fund's screens to Bloomberg -- is more difficult.

"That's harder to prove, but that's something that's hard for every active manager to prove," Budde said.  

Edited by: Marie Glancy

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