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Ethical funds change with the times

Socially responsible investing, once considered part of the 'left-wing, left-coast' political agenda, is moving toward the investing mainstream, RICHARD BLOOM writes

The times they are a-changin'. . .

Alongside roller-coaster-like markets, sweeping reforms of corporate governance on the back of accounting debacles and a complete overhaul of the geopolitical landscape in recent years, the world of socially responsible investing (SRI) is also changing.

"People feel SRI is some kind of left-wing, left-coast political agenda they can't buy into. Really, the values we intend to incorporate are the values held by the vast majority of Canadians," says Bob Walker, vice-president of SRI policy and research at Ethical Funds Inc. in Vancouver.

"And any survey data will show that the vast majority of Canadians feel companies should treat their employees well, should have good relations with their communities, should not pollute the environment, should be taking active steps to improve environmental performance, etc.," he explains.

"Those precisely are the values we have in our programs."

Mr. Walker, whose firm offers nearly 20 funds that fit under the SRI umbrella, defines SRI as the integration of social, ethical and environmental values into the traditional process of making investment decisions of buying and holding stocks.

Ethical Funds' products make up about one-third of the 54 SRI funds available to Canadians, all of which undergo a series of filters in order to be classified as "ethical" or "socially responsible."

The first step for inclusion in the Ethical's funds is screening -- not buying stocks of companies that participate in the tobacco, nuclear power or military industries.

Second, he explains, fund managers launch a series of "qualitative" screens -- looking for firms that encourage progressive community, shareholder and employee relations; those with strong human rights records; and those that show leadership on environmental issues.

However, a company's stock need not be eliminated from a fund if the company doesn't meet all of those qualitative screens. Instead, Mr. Walker explains, his firm will use various rights as shareholders such as the ability to propose resolutions at annual general meetings and dialogue with company executives, to effect change.

That multipronged approach is how SRI has changed in recent years, Mr. Walker says.

"The industry is shifting from a 'feel-good' approach, where people feel good about the stocks in their portfolio, to an approach that says the point of SRI is to make a difference in the world by making corporations better corporate citizens."

Howard Bogach, chief executive officer of Metro Credit Union in Toronto, says his organization tries to educate investors about the benefits of SRI. What's more, he also thinks the sector has shifted gears lately, with a large thrust placed on corporate governance -- especially in the wake of massive corporate collapses in the United States such as Enron Corp., WorldCom Inc. and the resulting losses to shareholders of billions of dollars.

"At one point in time SRI was the environmentalist group. I don't think it's there today," Mr. Bogach said.

"You've got a new breed out there that's saying: 'I don't want to invest in companies that aren't operating in a good governance model, I don't want to invest in companies that aren't disclosing information'," Mr. Bogach says.

"I want to have a good feel that my money is comfortable and safe . . . the issues about Enron and Tyco and everything that has come up has been huge."

However, he admits that there are those on both Bay Street and Main Street who will never be pleased with SRI.

Jim Stanford, an economist with the Canadian Auto Workers union, is in that camp of critics.

On a bitterly cold evening in January, hundreds of people packed into a University of Toronto lecture hall to hear Mr. Stanford and Mr. Walker debate the pros and cons of SRI.

Mr. Stanford argued that ethical investing is a contradiction in terms and that no real change can be made through SRI.

"The vast majority of financial wealth in Canada is concentrated in the hands of a surprisingly small social and political elite," he told the forum.

"And if we think those folks are going to join our ethical bandwagon, I think we'd better wake up and smell the cappuccino here, because they know what side their bread is buttered on, and it's not on the side of egalitarian policies and social responsibility."

One of Mr. Stanford's key arguments against the concept is the screening process, and what he calls "loosey goosey ethics." He says the criteria are so mild "they're virtually meaningless."

After the smokes, guns and nukes are taken out of the picture, he argues, almost any other firm is fair game for SRI funds to invest in -- including a slough of companies he deems to have questionable ethics.

That list includes all five big Canadian banks, Walt Disney Co., Gap Inc., McDonald's Corp. and EnCana Corp., among others, he says.

"You take a few bad boys and put them aside . . . and then you can attach that powerful word 'ethical' to your portfolio at the end of the day," he said.

As a result, many funds that mirror either a market index or a specific sector are nearly identical to an SRI fund trying to do the same, he argues. What's more, he says, investors don't have to pay the same management fees for index funds as they do for many SRI products.

Mr. Stanford also notes that not buying shares in a company has virtually no impact on the firm, as stocks are often bought from other investors and not directly from the company.

Mr. Walker disagrees. He cites the California Public Employees Retirement System (Calpers), with an estimated $150-billion (U.S.) in assets, which stunned Asian markets when it said it would sell off roughly $1-billion in assets in the Philippines, Thailand, Indonesia and Malaysia because they did not meet tough new standards ranging from trading liquidity to human rights.

After the announcement, Thai officials launched discussions with Calpers, a strong advocate of SRI, to try to woo the pension giant back.

"The fact Calpers was effectively excluding the entire country from their investment portfolio meant a hell of a lot to them . . . that said a lot of what screening maybe could do once the big [Canadian] players get on board," Mr. Walker says.

But what about the bottom line?

Logistics aside, there remains a stigma that if you don't sacrifice your morals when making investment decisions, you do sacrifice returns.

But that argument is not always true, especially when comparing some of the industry's most popular SRI funds and the more conventional non-SRI funds available. In fact, the performance is surprisingly similar.

Take Meritas Mutual Funds' popular Jantzi Social Index fund, which tracks 60 Canadian "socially responsible" stocks.

As of Feb. 28, the fund was down 13.7 per cent over the past 52 weeks.

Barclays Global Investors Canada Ltd.'s iUnits, tracking the S&P/TSX 60 index, are down 13.1 per cent during the same period.

"Our own experience would show that . . . there are times in the market cycle when screens will hurt, but there are other times when the screens will help," Mr. Walker says, noting the current environment that has seen energy stocks -- key holdings in some Ethical funds -- climb.

"And that in general, over time, the screens do not have an impact on performance."

Despite some of the criticism, Mr. Walker maintains that SRI does help change corporations and in turn, the world.

"How the world looks in 20, 30, 40 years matters. It matters where the sea level is, it matters what the state of the world is in to your children.

"You can make a difference, and I think it's up to us in the SRI industry to demonstrate now, how active shareholders should be in making that difference."
Top five SRI funds

1. Investors Summa
Assets: $1.8-billion
One-year performance:
Down 23.25%
Top 5 holdings: Sun Life Financial Services of Canada Inc.; Suncor Energy Inc.; Bank of Nova Scotia; Precision Drilling Corp.; BCE Inc.

2. Ethical Growth
Assets: $429.5-million
One-year performance:
Down 16.82%
Top 5 holdings: Bank of Nova Scotia; Alcan Inc.; Canadian Imperial Bank of Commerce; Encana Corp.; Petro-Canada Inc.


3. Ethical balanced
Assets: $424.5-million
One-year performance:
Down 8.65%
Top 5 holdings: Government of Canada bonds; Bank of Nova Scotia; Royal Bank of Canada; Power Corp.; Magna International Inc.


4. Ethical Income
Assets: $183.5-million
One-year performance:
5.86%
Top 5 holdings: Government of Canada bonds; Province of Alberta bonds; Ontrea Inc. bonds; Province of B.C. bonds


5. Ethical North American
Assets: $148.7-million
One-year performance:
Down 33.61%
Top 5 holdings: UnitedHealth Group; American International Group; Freddie Mac; Pfizer Inc.; Citigroup Inc.
All data as of Jan. 31

© 2007 The Globe and Mail. All rights reserved.

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