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When bad things happen to good investors

Ethical funds may be fine for the soul but their current returns suggest they may be less than healthy for the pocketbook. ROB CARRICK looks at whether this is just a temporary slump


Here's a warning to people who buy socially responsible mutual funds: Sometimes, investors with good intentions end up with bad returns.

One of the oldest and highest-profile socially responsible funds, Ethical Growth, is coming off three consecutive below-average years after a good run in the mid-1990s. Investors Summa, the largest ethical fund by assets at $2.7-billion, has also stumbled after some great years, while several smaller funds done much worse.

A key benchmark for ethical investing in Canada is the Jantzi Social index, a grouping of 60 stocks chosen for their ethical practices. The Jantzi index lost 11.6 per cent from its January, 2000, inception through April 30, while the S&P/TSX 60 index lost 10.3 per cent and the S&P/TSX composite lost 6.5 per cent.

Socially responsible funds tend to weed out companies in a few nasty sectors such as tobacco, nuclear power and weapons of mass destruction. Elsewhere, these funds seek businesses that stand out for their policies in areas such as the environment and relations with employees and the community.

If you see a resource stock in a socially responsible fund, it's because the company stands out in its sector for doing business ethically.

It's arguable that you can do some good for the world by owning ethical funds, especially with some funds using their influence as shareholders to try to influence corporate behaviour for the better.

But what about your investment portfolio? Are socially responsible funds a second-rate investment, or are they just in a slump right now?

There's no denying that these funds currently are unappealing on a pure performance basis. Even advocates of socially responsible investing (SRI) agree there are problems.

"Over the last couple of years, the performance of socially responsible funds has been below that of the industry, there's no question about that," said Michael Jantzi, the man behind the index.

Mr. Jantzi says the problem comes down to the strong performance by a few sectors that socially responsible funds have limited exposure to, or ignore altogether.

Defence stocks have done well in the wake of Sept. 11, but it's an article of faith with many ethical funds that they don't invest in this sector. Also, some sin stocks, Philip Morris, for example, have done well because they're viewed as a defensive investment in turbulent times.

In Canada, Mr. Jantzi said, the strength in the oil and gold sectors may pose a problem for socially responsible money managers.

It's not that these funds can't buy oil or gold stocks -- they can, as long as the companies are best-in-class for such things as environmental practices. The problem is that an ethical fund may end up with a small number of oil and gas stocks, giving it less exposure to these hot sectors than other funds.

Mr. Jantzi's index has only one stock with exposure to the gold sector, Teck Cominco Ltd., and he says the index is underweight in oil stocks compared to the broad market.

Ethical Growth is actually overweight in gold and oils right now, says Martin Gerber, one of the fund's team of managers at Vancouver-based Connor Clark & Lunn. He said the fund's weak performance numbers over the past couple of years can be blamed in large part on Nortel Networks Corp.

There was no Nortel in Ethical Growth in 1998-99 because the company had interests in Myanmar, an Asian country with a bad human rights record. Only in late 2000 and early 2001 did the fund did take a small position in Nortel.

"The reality is we didn't get the upside on Nortel, and we got some of the downside," Mr. Gerber said.

Ethical Growth has delivered above-average returns in nine of the past 15 years, but its recent numbers are so depressed that the compound average annual gain for the three years to March 31 is just 2.3 per cent, compared with 8.8 per cent for the average fund.

Mr. Gerber says this isn't unusual with the screening systems.

"Over any short period of time, there can be both a positive or a negative implication of having some stocks that can't be invested in," he said. "But what we've experienced over the long term is that SRI doesn't make a difference."

Ethical Growth's numbers suggest there is something to this argument. The fund's compound average annual return for the 15 years to March 31 was 8.1 per cent, versus 7.7 per cent for the average Canadian equity fund. The 15-year return for Investors Summa is even better at 8.8 per cent.

SRI have taken some encouragement from a study published in a recent issue of a financial trade magazine called Canadian Investment Review. Basically, the study concluded that investors neither give up nor gain performance if they buy funds run on ethical guidelines, and that socially responsible funds can be less risky than traditional funds.

But the study isn't all that persuasive, at least on returns.

For one thing, it contains 10-year data based on the performance of just two funds (Ethical Growth and Investors Summa) and five-year data based on four funds. Analyzing such a small pool of funds -- there are few SRI funds in Canada with a long track record -- doesn't make for conclusive results.

Another difficulty is that the funds in the study didn't actually outperform the S&P/TSX composite index and its predecessor, the TSE 300 composite index. The average 10-year fund performance for the period from January, 1990, to December, 1999, was a scant 0.4 percentage points below the index, while the five-year average for the four funds was almost two points lower.

The funds compared favourably with the index on a risk-adjusted basis, but the fact remains that their bottom-line returns were somewhat lower. In the short term, things look a fair bit worse for many socially responsible funds.

Investors Summa is one of the brighter lights in this dark period. Its 1.4-per-cent return in the past year compares with the average fund's 6.4 per cent, while its three-year return of 8.4 per cent is half a point or so below the average.

Other socially responsible funds have been much worse. The $108.5-million Desjardins Environment Fund has a wretched three-year average annual return of 1.4 per cent and it's one-year return was a tick less than half of the average fund.

The $170.1-million Acuity Clean Environment Equity Fund has been in such a rut that its five-year average annual return is down to 0.9 per cent. Ethical Balanced has been below average in its category for four straight years.

Even some of the new crop of socially responsible funds have been woeful. Mackenzie Universal Global Ethics lost 17.1 per cent in the past year, which compares with a loss of just under 3 per cent for the average global equity fund. The $8.2-million Meritas Jantzi Social Index Fund, an index fund that tracks Mr. Jantzi's index, made 0.3 per cent in the past year while the average Canadian equity fund made 6.4 per cent.

Let's just say it's inevitable that socially responsible funds will give you a rough ride from time to time. If you want to invest in these funds, be prepared for it.

As for long-term results, Investors Summa and Ethical Growth are among the very few funds with the numbers to back up the assertion that socially responsible funds don't penalize investors. If you're looking to invest with a conscience, start your search here.
The goods on socially responsible investing
Here's a look at how some of the largest socially responsible equity funds in Canada have performed over the short and long term.
Canadian equity funds

                                  Assets             Returns*

Fund                              ($million)   1-year  5-year   10-yearInvestors Summa                      $2,700    +1.4%   +11.3%   +11.7%

Ethical Growth                          601    +5.3     +3.6     +8.3

Acuity Clean Environment Equity         170    -5.2     +0.9     +8.9

Desjardins Environment                  108    +3.1     +5.1     +7.4

Average for all Cdn. equity funds              +6.4%    +7.1%   +10.3

U.S. equity funds

Ethical North American Equity          $244    -9.2%   +10.9%   +12.5%

Ethical RSP North American Equity        26    -9.7    --       --

Average for all U.S. equity funds              -2.8%    +8.4%   +10.7%

Global equity funds

Ethical Global Equity                   $33    -8.8%   --       --

Acuity Clean Environ. Global Equity      26   -18.5     -1.9%   --

Ethical RSP Global Equity                16    -9.2    --       --

Mackenzie Universal Global Ethics        16   -17.1    --       --

Average for all Global equity funds            -2.9%    +6.0%    +9.3%

-*returns are for the period ending March 31, 2002

© 2007 The Globe and Mail. All rights reserved.

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