Socially Positive Portfolios

The Christian Science Monitor has an article on a new breed of investors who use a POSITIVE screening method:

When money manager Lloyd Kurtz listens to clients these days, he hears a message that's gaining currency across the world of ethical investing.

"The most common question I get from clients is, 'How can we make this portfolio more socially positive?' " says Mr. Kurtz, a senior portfolio manager at Nelson Capital Management in Palo Alto, Calif. "Just avoiding bad companies doesn't cut it anymore."

One solution has been positive screening - a strategy that sets the social or environmental bar high enough so that only top-performing firms win an investor's dollars. The approach breaks from the status quo of socially responsible investing (SRI), a movement now in its fourth decade. To date, SRI mutual funds have emphasized a two-pronged approach: negative screens, which avoid certain companies, such as those connected to tobacco or weapons manufacturing; and shareholder activism, which pushes for policy changes inside companies that have questionable practices.

According to certain measures, such conventional SRI methods have been struggling. Having largely avoided market-leading petroleum and defense industries, the benchmark Domini 400 Social Index trails the Standard & Poor's 500 in returns over one-, three-, and five-year periods.

So some ethically minded investors are seeking a new way to link investments with personal values by exploring what positive screening has to offer. A few new mutual funds in the United States and Canada have popped up to satisfy that demand.

But investors should use caution before they plunge into positive-screened funds, says Christopher Geczy, an assistant professor of finance at the University of Pennsylvania's Wharton Business School. In an updated study of mutual-fund performance over the past 40 years, he found that investors who put limitations, including positive screens, on the funds they considered tended to receive lower annual returns. In fact, their returns were three to four percentage points less than their counterparts who put no restrictions on their portfolios. The reason: inadequate diversity to buoy lackluster performers in down markets.

But some money managers are hopeful that positive screening will yield more profitable harvests. Risks have diminished over the past five years, they say, because more public companies measure up to ethical standards.

One fund generating some excellent results lately is the Winslow Green Growth Fund. Portfolio manager Matthew Patsky hunts for small "environmentally proactive" companies, meaning those whose primary products somehow enhance the environment, such as solar energy or natural foods.

To strike a balance across industries, Mr. Patsky chooses some firms that are either environmentally "responsible" (e.g., a paperless travel agency) or "benign" (e.g., software). Unlike many SRI funds, Winslow Green Growth avoids "best in class" performers from what Patsky terms "dirty" industries, such as petroleum. And the fund doesn't agitate for social change inside the firms it owns.

Results tell Patsky he's onto a winning, albeit sometimes volatile, formula. Up 31.6 percent over the past year, the fund's average returns over the past three, five, and 10 years have been 35.3, -2.5 and 20.0 percent, respectively. Still, the dangers of trusting primarily in "proactive" firms delivered a painful lesson in 2002 and 2003 when renewable-energy stocks tumbled.

"It was a major bet that was wrong," Patsky says. "What we were betting was a rational outcome to an analysis of what happened on 9/11," but investors didn't flock to oil alternatives as he'd expected. As a consequence of that experience, proactive stocks now make up just 25 percent of the portfolio, as opposed to the 50 percent they represented in 2002.