Socially Responsible Investing – Is It for the Greater Good?
Warren Ward Associates has been asked to look into Socially Responsible Investing (SRI) several times over the years. We have encountered similar issues each time, including:
- Different people have different definitions of SRI. Investing in a portfolio which does not contain shares of nuclear power generation companies may seem "SRI enough" to one person while another may wish for no power generation at all. Perhaps the safest investment in the world is the US Treasury bond, yet T bonds are considered "non-SRI" by some investors, due to their implicit support of various US government policies.
- SRI is a concept which has attracted less than 1% of investe assets in the US so the very best money managers have yet to offer the strategy. This provides WWA with many fewer options from which to choose and, among those managers who are available, few have track records longer than five years. Also, due to the limited invested assets, SRI has not attracted managers in all of the investment categories which we believe to be necessary to reduce portfolio volatility.
- Businesses "go public" and begin trading on a stock exchange when they require more money for growth than the founders are able to invest (or borrow) on their own. In all but a very few cases, the only time a business realizes money from the stock markets is at this time – during the switch from "private" to "public" ownership. Although stock prices are likely to go up or down every day afterwards, the company realizes no more or less value than the amount they received initially. Since day-today fluctuations in stock price do not directly affect a publicly traded company, it is not harmed by SRI investors avoiding its stock. Further, after reviewing the SRI question several times in the past ten years, we have yet to see research confirming that the pressure of SRI investors withholding their investment dollars has materially affected company decision-making.
In general, SRI investing has been less profitable for investors than non-SRI alternatives. Our favorite Large Cap Value fund, Selected American shares, has returned 8.51% to its investors over the past five years. One of the better known SRI funds, Pax World, has a similar investment goal but has returned 6.86%. On an initial investment of $10,000, the difference in rates of return is about $1,100.
Would it be fair to describe this difference as a tax on social responsibility? If so, is it one you feel obligated to pay? If you had accepted the higher rate of return, then donated the difference to the charity of your choice, you would have been allowed to select your personal definition of Social Responsibility and received tax credit for your support. Since SRI investing seems to have had little or no effect on the socially responsible actions of the companies, you would probably not have affected the SRI cause one way or the other.
It is our observation that SRI is a strategy embraced by people with the best of intentions: those who hope to change the world for the better. However, we have come to see it as a relatively inefficient way to bring about change. If social change is one of your goals, you might accomplish more by investing your time and money directly in the service of others. There are worthy causes throughout our community, country and world that would benefit more from your dollars than any corporation is likely to suffer from the lack of them.
WWA does provide SRI alternatives for clients who make that choice but we ask that the decision to use the strategy be made thoughtfully. We have chosen what we hope will be the best SRI investment managers but we still anticipate that rates of return will be lower and portfolio volatility higher.
More “General” than “Electric”
One of the most commonly asked questions in the investment world is whether people are better off investing through active or passive strategies. Most mutual funds feature active management (specific stocks are chosen) while the lower-cost index funds (in which a specific index is mimicked) do not. This leads to the obvious question: are the managers "worth it"? As with so many issues related to financial planning, this question is harder to answer than it first appears. As we understand things at Warren Ward Associates, each strategy involves its own share of "management". For example, back in May of 1896, when Charles Dow published the members of the first Dow Jones Industrial Average (DJIA), he selected ten very large and well-known companies for inclusion.
- American Cotton Oil
- Laclede Gas
- American Tobacco
- North American
- Chicago Gas
- Tennessee Coal & Iron
- Distilling and Cattle Feeding
- US Leather
- General Electric
- US Rubber
If you follow investing at all, you probably recognize that only one of them remains a part of that index today and it has become much more General than it is Electric. GE was founded in 1878 by Thomas Edison to commercialize his invention of the light bulb. The company has remained a component of the DJIA through the years by changing with (and sometimes ahead of) the times. It is now active in six broad market areas: commercial finance, consumer finance, healthcare, industrial, infrastructure and the diversified media company, NBC. Two things have not changed: it still sells light bulbs and its continued membership in the DJIA is at the discretion of the editors at Dow Jones.
Another well known index is the Standard & Poors 500 (S&P 500) to which GE also belongs. The S&P is not comprised of the 500 largest companies in America (although that’s not a bad way to think of it) but 500 companies which a group of S&P editors believe to be of the greatest interest to investors. I thought about calling this article "The S&P (1)500" because over the years, more than 1500 different companies have been members of the "500".
Neither Dow Jones nor S&P publishes a timetable for making changes but adjustments among one or the other happen almost every year. The DJIA hit a record of 13,000 in 2007. Did you know that if IBM and Coke had remained a part of the index, instead of being removed then later added back, it would have already hit 15,000? That’s a fact and it highlights the issue that WWA sees with passive investing.
In spite of being thought of as passive, each of these famous indices is "managed", at least after a fashion. We prefer active management for our clients for one simple reason. Since changes in portfolio composition are going to be made, we think the best strategy is employing investment management professionals to make investment selections for our clients rather than the editors at Dow Jones or S&P. It is true that index investing generally offers lower costs but we believe that utilizing active managers provides us with an opportunity to control portfolio volatility while still providing competitive rates of return.
N I M B Y
One of the truths of modern life is that we have come to enjoy and even expect certain comforts which would have been beyond the wildest dreams of earlier generations. We have become accustomed to indoor plumbing, central heat and air conditioning and the availability of electricity at the touch of a switch. As much as we desire these comforts, there is frequent resistance to the infrastructure necessary to deliver them, hence the acronym NIMBY, meaning Not In My Back Yard.
Back in the early 1950’s, I’m sure the residents of Columbus were very glad to have a wastewater treatment plant installed south of downtown. However, now that "town" has moved closer to that site, plans have begun to move the plant away from the "backyard". Similarly, the building or expanding of power plants has become a "hot button" issue for many Americans, regardless of the country’s potential need for additional electric power. Getting by with fewer plants or building plants which are "out of the way" might be a sensible strategy but that solution requires additional high voltage lines to deliver power to our communities. Although I am unaware of scientifically-based research linking those lines to increased illness, many people are as reluctant to live near them as power plants.
Coal-fired plants provide the lowest-cost electric power but mining operations are not pretty and some people want to do away with coal power, end-to-end. Nuclear power is clean and non-polluting but people can’t forget the scare at the Three Mile Island plant in 1979 or the very real effects of the 1986 failure at the Chernobyl reactor in Ukraine. In doing research on Socially Responsible Investing for some clients, I came across a mutual fund that would not invest in a power company which utilized nuclear power but did not have a problem with coal-fired operations. Who’s to say what is acceptable and not?
With rare exceptions, communities are reluctant to permit major infrastructure projects in their back yards. One atypical response comes from the city of Richland, WA. Richland is near the Hanford nuclear plant which provided weapons grade plutonium for the country during the cold war years. Appreciating the jobs which the plant brought and continues to provide, most of its citizens remain supportive of the operation. The school even named its sports teams "The Bombers".
The federal government has become interested in using ethanol as a replacement for imported oil and it subsidizes ethanol productions in several ways. At first glance, many people applaud the idea of using ethanol to reduce oil imports. Ethanol plants do not make sense to everyone, however. Much of our arable land is found in the Midwest. Recently, protests have begun to keep such plants from being built in several Midwestern states. In Cambria, Wisconsin, sides have been chosen. Not surprisingly, the Chamber of Commerce and farmers support construction of an ethanol plant by a local corn processor but most long-time residents do not. Those in favor see it as a way to bring jobs to the town and ensure demand for corn. Those opposed worry about air pollution, heavy truck traffic and depletion of the water supply. They are also concerned that existing environmental issues at the corn milling operation do not bode well for the company’s ability to handle a new and much more complex ethanol plant. A recent article in the (2007) Wall Street Journal offers a detailed report on this story and related issues. Let us know if you’d like to read it.
What position shall we take in a situation like this? Should small towns embrace power plants for the potential benefits they bring or should they oppose them out of fear of catastrophe, potential inconvenience or environmental concerns? Should they be compensated in some way for allowing plant construction?
There are no quick and easy answers to questions like these. They require study and time for serious consideration – a tall order in our high speed world – but they are too important to be dismissed in a rush to judgment.
Cui Bono
Cui bono, a Latin phrase meaning "to whom the good?" or "to whose benefit?" might be more familiar to readers of detective fiction as "follow the money". Trying to answer the question of who stands to gain from a criminal act is a staple of both fictional and real life crime solving. It can stand us in good stead in our daily lives as well.
Do you think that Expedia exists primarily to save you money on travel? According to its advertisements, it guarantees the best rates for you but, in fact, Expedia is an e-travel agency. It is paid commissions by the companies to whom it refers your business. In our capitalist society, the situation is pretty much the same wherever you look in spite of marketing which implies something different. "We value you!" may be the truth, at least to some extent, but I think most retailers primarily value our willingness to spend our money with them, not us as individuals.
At various levels, governments are involved in commercial arrangements, too. Perhaps you are already familiar with a government entity selling or leasing something to increase revenues without having to raise taxes. Some examples:
- The federal government sells rights to use the airwaves for transmitting radio, TV and cellular signals. After being paid for by various businesses, these channels are then used to deliver information. We are either charged individually or advertising is sold to cover the costs plus yield a profit.
- The State of Indiana investigated selling the right to build a private toll road. If the plan had gone ahead as contemplated, the state would have received a cash payment from the developer, who would then build the highway and recoup the investment over time through the tolls charged for driving on the highway. My guess is that similar strategies will emerge in the future.
- Earlier this year, the State of Illinois auctioned off the right to manage its 529 college savings plan. The winning bidder was Oppenheimer Funds which paid Illinois $2.1 billion to operate the plan for the next seven years. How do you suppose Oppenheimer expects to earn that investment back? Do you think fees paid by account holders might be involved?
Warren Ward Associates is part of the world of financial planning and investments which includes innumerable sources of free advice. Here’s the "follow the money" question: what’s in it for them? Do these resources exist to help you make money out of the goodness of their hearts? I think it’s more likely that they hope to increase reader/viewer ship so as to sell more ads. Regardless of how entertaining the TV personality, newspaper column or website appears to be, please remember that their business model requires that they attract attention. Those presenters are only able to offer the most generic advice and they could even be taking an unorthodox or controversial position simply to generate "buzz" and attract a larger audience.
All businesses must operate profitably to stay open, including investment-related ones. Any "free" advice provided is simply being paid for in an alternate way. Your insurance agent and stock broker receive commissions for the investment products they sell you. Your CPA and attorney (and WWA) charge a fee for the advice you are given. In every situation where you are a customer, you should understand exactly what you are buying and what price you are paying for it. As important as it is for fictional and real detectives, following the money also can be a very useful strategy in the world beyond crime solving.
The Dismal Science (of Economics)
According to the invaluable Wikipedia, historian and writer Thomas Carlyle (1795-1881) is credited with naming economics the "dismal science" in response to Thomas Malthus’ dire predictions about the result of uncontrolled population growth. Beyond specific concerns related to population, economics is also the study of capitalism and is a required topic of discussion as investment strategies are contemplated.
The continuing growth in the value of companies traded on the various stock exchanges around the world sometimes seems to take on an almost mystical aura – where is all that value coming from? Poker and most other forms of gambling are known as "zero sum games", meaning that the game itself adds no value to the total amount being gambled. For one person to win, another must lose. Yet, total stock market valuations have increased over time and, while corrections are certainly a part of the equation, it is not necessary for one person to lose money for another to gain it.
How can this be possible? Let’s begin by thinking about why companies "go public" and arrange for their shares to be traded on an exchange.
When a company finds that it needs more money than can be contributed (or easily borrowed) by its founders, it can offer a portion (a share) of its ownership to individual investors. Once such an offering is complete, subsequent fluctuations in stock price do not directly affect the company. Instead they add to or subtract from the worth of the investor-owners. Remember the huge demand for Initial Public Offerings during the "dot com" boom of the late 90’s? Company founders wanted to take some cash out of their businesses but small investors were clamoring for their chance at sudden growth through these IPOs.
It is this constant change in valuation that supports "Wall Street" in the sense that it is commonly thought of: a specific place where securities may be traded. In fact, stocks and bonds can be sold on any street corner in the world if a willing buyer and seller should happen upon each other and agree on a price. Since that is a pretty unusual occurrence, stock and bond exchanges developed to facilitate systematic trading. They exist so that share owners can easily (and transparently) buy and sell securities. Whether the market is primarily a trading floor like the NYSE or is strictly electronic like the NASDAQ, these exchanges make it possible for investors to purchase/sell literally billions of shares daily. This huge volume of transactions assures that there will always be a buyer for shares we own or a seller for those we wish to purchase. The NYSE itself is a publicly owned company, with its shares (naturally) traded on its own exchange.
At WWA, we almost never recommend very low-priced "penny" stocks, also avoiding the "pink sheets" where they trade. Beyond that, however, we really don’t care on which exchange a stock (or bond) is traded. As long as regulators continue to make such transactions both easy and secure, we can concentrate on our job of advising clients about which assets they should own and in what proportions.
Try a Little Randomness
I just finished reading a pretty interesting book called How Doctors Think by Jerome Groopman, MD. It deals with several different medical issues but its central theme is how a physician might make and stick to a diagnosis, even though contradictory facts later come to light. Although the author was talking about medical treatments, I think that most of us have probably done something similar at one time or another.
I had been thinking for several months about cleaning our basement dehumidifier. Last week, I went into the hardware store to purchase some of the chemical spray that I had seen service technicians use in maintaining air conditioning coils. I had already settled on the process I’d employ, even though I knew it would be wet, messy and would require heavy lifting. The helpful hardware man did not have any cans of coil cleaning spray but said that he just left his dehumidifier where it was, used a small brush on the coils, then vacuumed-up the dust.
Another book I read recently is A Perfect Mess by Eric Abrahamson and David H. Freedman. Although I picked it up because it opens with a defense of messy people, the last half of the book presents several situations in which some measure of disorder might actually be a good thing. For example, jaywalking is statistically safer than crossing the street in a crosswalk. Why would that be so? According to the authors, jaywalkers know they are breaking the law and are very careful to look in all directions before and during crossing, thus suffering fewer accidents. Another example is home organizational consultants who make everything fit by tossing out the very things which would bring us the greatest pleasure when happened-upon in old age. A third example cited was that the free-form nature of "ultimate fighting" actually makes it safer than traditional boxing according to statistics. Carl Sandburg once said: "Nearly all the best things that came to me in life have been unexpected, unplanned by me".
For me, the learning experience at the hardware store, these books and Mr. Sandberg’s quote combine to highlight and answer a single question. What happens when any of us makes a decision and sticks to it without deviation, when deviation might be the best way to solve a problem? The authors of A Perfect Mess note that "organizations can be messy in highly useful ways". They urge companies to keep things flexible enough to provide the opportunity for rethinking and change. Dr. Groopman summarizes How Doctors Think with the suggestion that you help your doctor by being sure to let her or him know what might have changed since your last visit and by occasionally asking: "What else could it be?" In the case of your investment life, helpful discussions might start with: "Remind me again why this strategy is appropriate for me." or "Has anything changed that might make another strategy more appropriate?", or simply "Is there a less expensive way to implement this strategy?".
Physicians and financial planners alike are trained to ask good questions, listen carefully to the answers and always be alert for clues related to things left unsaid. Whether dealing with your health, your finances or the cleaning of a home appliance, I think clear and open communication – and a willingness to change directions once in a while – offers a good basic approach to problem solving.
Sometimes, Great is the Enemy of Good
I do a considerable amount of reading about business issues, searching for insights into various business models and practices. I was among many thousands who read Jim Collins’ 2002 best seller Good to Great - Why Some Companies Make the Leap…And Others Don’t. After investigating a number of highly successful companies, Mr. Collins came to believe that good is the enemy of great, that complacency breeds mediocrity. He encouraged his readers to challenge the “good is good enough” philosophy if they wanted their businesses to reach the level of greatness.
During the tenure of recently retired CEO Doug Leonard, Columbus Regional Hospital offered us a local illustration of this concept. Mr. Leonard related that some years ago, the unstated motto at CRH was something along the lines of “Better than Seymour, almost as good as Indianapolis”, which sounds like a working definition of good is the enemy of great to me. That mindset held CRH back until the board and staff began to challenge assumptions about the status quo. They found that health care quality could actually be measured. The hospital staff began to compare itself to hospitals all over the state, setting benchmarks in numerous categories. As a result, CRH changed the way it delivers health care and has become one of the premier medical facilities in Indiana.
Thinking about this concept, I began to wonder if there might be situations in which the opposite could be true, when great might be the enemy of good. What if a batter who had been helping the team by consistently hitting singles and doubles began trying to hit a home run every time she came to bat? Most likely she would strike out (or fly out) more often and, in an attempt to achieve greatness, might instead become less valuable to the team.
I believe something similar can occur in our investment lives. Although few people actually achieve outstanding investment results, that is the aim – or at least the hope – of many. In search of “great” returns, people chased high tech and “doughnut shop” IPOs in the late 90’s, only to suffer significant losses in the correction which followed. Attention spans are short, however, and now we are hearing a lot of questions about hedge funds. The best of these funds are not available to middle-class investors and most of the rest have moved far away from the “hedged” investment strategies originally contemplated. These make no sense for most people but have become a distraction to a disciplined investment process.
By constantly changing strategies in search of “great” results, people risk missing out on the long term investment success available through “good” stock market investing. If a good return could reasonably be defined as doing as well as the S&P 500, then the well-known Ibbotson chart provides us with an example of what good might be. The chart shows that it requires eleven dollars today to equal the purchasing power of one dollar in 1925 but that same dollar invested in the S&P 500 in 1925 would be worth about $2,700 today.
In relation to peoples’ investment lives, I think good results will usually prove to be good enough. I understand that focusing on good returns does not necessarily provide that “lottery ticket rush” or sparkling conversational fodder but, in most cases, it can be counted on to provide a comfortable retirement. Warren Buffett once said that he’d rather buy a great stock at a good price than a good stock at a great price. He is our generation’s most successful long-term investor and I think his comment reinforces my point. In the world of business, striving for greatness might very well be the path to competitiveness and longevity. In the world of investments, I think achieving good results at the lowest possible level of risk is likely to be the best strategy for most people.
Warren, Bill and Warren
One of the great pleasures of my business life is having VIPs – very intelligent people - as clients. A few weeks ago, I named Warren Buffet the most successful investor of our age, so before one of my clients raises the issue, let me address the difference between his success and that of the richest person in America (in 2007), Bill Gates.
Although Buffet and Gates are both enormously wealthy and have even traded places in the number one position, their approach to wealth creation could hardly be more different. Bill is a classic entrepreneur who dropped out of college to start a business. Even though IBM knew a lot about computer software, its managers had decided that the process of bringing their Personal Computer to market was already complicated enough and were looking for a company to supply a basic operating system. Their decision to utilize DOS eventually left Microsoft with the sustaining technology, while IBM was pushed out of the hardware business by less expensive competitors. Bill’s efforts at keeping DOS, then Windows, as the his amassing the largest individual fortune in the country. He bet everything on his ability to deliver what IBM wanted, then worked hard to keep Microsoft number one.
Warren Buffet’s approach to investing is just the opposite. He gained control of Berkshire Hathaway with the intention of using its excess cash (that which was not needed immediately in its insurance operations) to make investments in various companies that he judged to be good long-term values. He has always said that he would never invest in a business that he couldn’t understand, which left out Microsoft and all computer-related companies. The portfolio he assembled includes stocks like Coke, Gillette and American Express, in addition to direct ownership of Shaw Industries, Benjamin Moore Paints and The Pampered Chef. Warren’s investment philosophy meant that he and his investors missed out on most of the tech boom of the late 1990’s but were also spared the worst of the subsequent tech bust of 2000.
It seems to me that the success of these two investors comes as a result of each narrowly defining a strategy, then executing it with an almost compulsive focus. Investors who followed these two different paths have both done well. Gate’s decision to “bet the company” has proven the more volatile but has resulted in the creation of many “Microsoft millionaires”. Those who have invested with Buffet’s more diversified approach have also been well-rewarded over the years. Although Bill Gates’ personal fortune is the greater due to the success of his very focused “bet”, Warren Buffet has also done extremely well for himself.
What are the chances that any single company’s stock will perform as well as Microsoft’s has? They are hard to calculate but certainly very slight. We believe that most individuals will be better served with an approach similar to that used by Warren Buffet. This is one of the reasons that Warren Ward Associates utilizes asset allocation as a primary strategy in managing our clients’ investments. We’d love to be able to see into the future and pick the single best stock but, until that becomes possible, we will continue to manage our clients’ assets as we have in the past, with a focus on reducing portfolio risk through thoughtful diversification.
