BI > AUGUST 2004

Investing For More Than Profits

by Nancy and Don Danko, NAIC Lifetime Members

We wanted to do this to help our three daughters learn more about investing and how our capitalistic system is helping to make a better world possible for people everywhere. It's turning out, however, that we're the ones doing most of the learning.

The exercise is opening the doors to a new world for us, the world of socially responsible investing (SRI), one that's attracting the interest of a growing number of individual investors as well as one out of every nine dollars under professional management in the United States. According to the nonprofit Social Investment Forum, more than 11 percent of all investment assets under professional management in the United States -- $2.2 trillion out of $19.2 trillion -- are in professionally managed portfolios using one or more SRI strategies.

We were introduced to this world in a rather unusual way -- by turning our backs to it and trying to avoid it. Like many other investors, we knew that so-called socially responsible funds were in operation, run by managers who were using various screens to help select companies that met specific social or environmental criteria. But to be truthful, the term "socially responsible" was a bit of a turnoff. The name itself implies some funds are not socially responsible, and that didn't set well with us.

We have our personal values, of course, just as most investors do. But we don't believe we have a right to say our values and the companies we choose to express them are any more socially responsible than the next guy's. What's more, we believe that people who follow NAIC investing principles and teachings have good reason to consider themselves socially responsible investors: They're investing for the long term in a way that helps to build companies, jobs, communities and our economy, allowing everyone to be a winner. Contrast that to the day-trader who's out to make a quick profit and run.

Thus we felt uncomfortable joining the traditional organized camp of socially responsible investors and turned our back to what that world was doing. Instead we began our own research aimed at finding five common stocks that reflect some of the things we value highly:

• Being concerned with more than making a profit.
• Being a positive force in the communities where we live and work.
• Helping the poor and the marginalized.
• Working for peace and justice.

To be true to our NAIC roots, each of the companies had to look good in our Stock Selection Guide studies. This gave us confidence that what we were doing reflected sound investment principles as well as our personal ideals.

A World of Grays

After choosing our first three stocks, however, we discovered the SRI world had plenty to offer investors like us who want to do our own research and make up our own minds about the merits of individual companies rather than simply being told by someone else whether those companies are socially responsible. The SRI world is about much more than telling us what companies to invest in or stay away from. It's a world that's helping investors identify profitable companies making positive contributions to society -- whether through commendable employer-employee relations, strong environmental practices, products that are safe and useful, operations that respect human rights or similar actions. SRI is very much a world of grays, not black and whites, in which companies aren't good or bad, just real. Viewed from this perspective there's a much more fitting name NAIC investors like us can use to refer to the world of socially responsible investing -- social screening.

Discovering this made us much more comfortable with the whole subject of social investing and how we could use existing research in our own stock studies and investment decision-making. As with the NAIC Growth Screen that appears regularly in BITS or other stock screens we've worked with in the past, the fact that a certain company appears on the screen is no guarantee that it would make a good addition to a portfolio.

As NAIC teachings emphasize, screening can be a help to successful investing only if it's used properly. That usually means screening is a first step, not the only step, to finding attractive investment candidates. Screening also casts little aspersion on companies that don't make the cut. We don't end up with a list of good companies or bad companies, or in our case socially responsible companies or socially irresponsible ones. Screening simply provides us with a list of prospective candidates from which we might choose one or more for further study.

We're far from alone in the NAIC community in looking at social investing. The Green Futures Investment Club of Beaverton, Ore., was formed four years ago as an experiment in socially responsible investing through which members hoped they could earn a reasonable return consistent with their personal values.

"We chose to start an NAIC investment club and to screen stocks not only the NAIC way but also for the social responsibility of the corporations we would invest in," says club member Jacque French. "That means we research how a corporation treats the environment, its workers and the communities where it does business. We pay attention to shareholder resolutions and check to see if the stock is held in socially responsible funds like Domini, Calvert or Citizen funds that do active screening."

The club quickly learned there aren't many perfect corporations. "But there are many that work toward environmental sustainability, fairness to workers and support to communities," French says. "We also have recognized others that look only at the bottom line and will do anything to keep it looking good for shareholders."

Green Futures has a 13-stock portfolio recently valued at about $14,000. Holdings are AFLAC, Baxter International, Bed Bath & Beyond, Bright Horizons, H&R Block, Harley-Davidson, The Home Depot, Kohl's Corporation, Medtronic, Omnicare, Paychex, Starbucks Corporation and Washington Mutual.

Editor's note: No investment recommendation is intended for any of the companies or mutual funds mentioned in this feature.

Building the Better World Portfolio

Social screening helped us with the fourth stock we purchased for the Danko Better World Portfolio and with another company we've placed on our watch list. But first, here's a summary of our first three purchases.

In 2003 we purchased 100 shares of Target Corporation in early February at around $27 (Better Investing, April 2003), 100 shares of Microsoft Corporation in mid-May at $25.63 (BI, July 2003) and 100 shares of Pfizer Inc. three months later at around $32 (BI, October 2003). All three companies looked good on our SSG studies, showing the potential to double in value over the next five years, with upside-downside ratios of at least 3-to-1. Each also appeared to us to have corporate values that include more than making a profit.

Target values community involvement and support, giving back more than $2 million a week to local and national nonprofit organizations in the communities it serves. Its focus is on programs involving the arts, education and family violence prevention. These programs represent an annual cost of more than $100 million, or about 7 cents a share. We value community involvement and were pleased to have it expressed in our Target holding.

That also was a value expressed by our Microsoft purchase. Its community affairs program, now more than 20 years old, was one of the first corporate-giving programs in the high-tech industry.

Today Microsoft is the largest contributor in this industry and the third-highest among all U.S. businesses. Last year the company gave more than $40 million in cash and $200 million in software donations to thousands of nonprofit organizations to help people and communities realize their potential. All of this was above and beyond the personal contribution made by the Gates family and the Gates Foundation to many lifegiving organizations.

Our purchase of Pfizer also reflected our desire to invest in companies whose corporate culture and values include more than making a profit. Pfizer donates hundreds of millions of dollars in medicine to help more than a million patients across the United States, while its contributions to health outside the United States are formidable. It's significantly involved in the fight to stem the spread of HIV infection around the world and to help those currently infected by the virus.

We made all our selections knowing there's no such thing as the perfect company. In a 60-page profile on Pfizer, for example, KLD Research & Analytics notes many of the company's social strengths but also such concerns as high compensation in the corporate governance area and hazardous-waste issues in the environmental area.

The Green Futures Investment Club recently sold its shares in Pfizer because of concerns over shareholder resolutions, the company's participation in the new Medicare law from which it will benefit and its restrictions on Canadian drug sales.

The Difficulties of Social Screening

We had little difficulty finding attractive companies to invest in that value more than making a profit and that had significant programs of community support and charitable giving. We discovered it wasn't quite so easy to express some of our other values in stocks we were purchasing for the portfolio -- values like helping the poor and marginalized or working for world peace and justice. These qualities aren't commonly mentioned in the operations or reporting of publicly traded companies, and they're difficult qualities to establish a set of criteria for.

In addition, as we noted in last October's BI article ("Building That 'Better World' Portfolio"), opinions can vary significantly on what companies are supporting world peace. A defense company we might exclude from further study because of its role in supporting our military effort might be the same company another investor would include for the same reason, seeing the military effort as leading to peace. We can debate the reasoning and the thinking but not the intentions of the heart.

Including social screening as part of the investment process often does involve our hearts as well as our heads, something sure to draw criticism from those who believe there's no room for emotions in investing decision-making. We don't agree. Our experience is that successful investing can involve hearts as well as heads.

And while we're mentioning body parts, let's add stomachs, too. In the words of one professional investor. "People think they hire me for my head, but they really hire me for my stomach. How much pain and suffering and uncertainty can I endure when a stock or a market isn't performing the way I expect it to? At times like that, staying invested is very much a function of the stomach."

Certainly emotions must be under control when we're involved in investment decision-making, but they can play a role. Take our desire to find a financial company that's making a significant contribution in helping those most in need of financial resources. It's something our hearts want to see. There are many fine companies in the financial sector that are well-managed, principled and focused on long-term growth.

But serving the financial needs of some of the poorest people on the planet is likely to be just a modest part of their business operations at best. That's OK. Even a modest contribution is a statement of values and a contribution to a better world.

Deutsche Bank recently caught our attention by announcing such an effort. The company is putting together a $50 million facility that will underwrite small banks and small loan funds. The $50 million may not be much in the context of Deutsche Bank's total loan portfolio, but the move represents a commitment on its part and a lot of money targeted to help meet the financial needs of some of the poorest people in the world. It's likely other financial companies are making similar commitments.

In April we were excited to read this headline on the front page of The New York Times: " Debate Stirs Over Tiny Loans for World's Poorest." The article dealt with one of our Better World Portfolio values and provided a lot of information about microcredit programs. Most of the initiatives, unfortunately, were launched by nonprofit or private firms rather than by publicly traded companies. According to the Times article, 50 million people, many among the poorest of the poor, currently take part in microcredit programs. It's a subject that remains on our radar screen and may well lead to a future addition to our portfolio. What a wonderful example of how we can invest with both mind and heart.

Adding Fannie Mae

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It was an article in Business Ethics, a quarterly publication that for the past 15 years has been advocating greater social responsibility in business, that led to our purchase of a financial company and the fourth stock in our Better World Portfolio. The article also introduced us to the benefits social screens can bring to our stock study efforts. The feature was the " 100 Best Corporate Citizens for 2004" in the magazine's spring 2004 edition. The Minneapolis-based publication has been running such a list for the past five years. its aim is to identify firms that do an exceptional job of serving a variety of stakeholders, including shareholders, the community, minorities and women, employees, the environment, non-U.S. stakeholders and customers. Research data primarily comes from KLD Research & Analytics, Inc., a Boston-based independent investment research firm well known for its Domini 400 Social index, a popular benchmark for measuring the impact of social screening on financial performance.

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A total of 29 companies have made the list in each of the past five years. They're shown below along with their rankings in the 2004 list. What caught our attention was that a financial company, Fannie Mae, was on the list of the best corporate citizens for all five years and was at the top of the 2004 list. One example of the policies that earned Fannie Mae the No. 1 spot was the Native American Conventional Lending Initiative it created to help finance $75 million in loans on trust land for the Navajo Nation of Arizona, Oneida Nation of New York and Menominee of Wisconsin.

The company is dedicated to the American-dream business -- helping Americans become homeowners -- which is the basis for its unique chartering by Congress. Fannie Mae's most visible impact is on helping those who traditionally have been underserved by mortgage lenders to obtain home loans.

According to Business Ethics, in 2003 more than $240 billion in home mortgages were financed for 1.6 million minority first-time home buyers. That was an increase of 60 percent over the prior year.

"Most uniquely," Business Ethics said in its article on the 2004 list, "a $10 million Fannie Mae partnership was established with an Islamic financial institution to open up Southern California's real estate market to Muslims. It accommodates Islamic law's ban on paying or collecting interest on debt by negotiating monthly payments based on a property's sale price and fair rental value instead of interest rate."

In the magazine's 2004 listing of best corporate citizens, Fannie Mae tied for the second-highest score in service to minorities and women. Little surprise. "How are we going to accomplish our goal of bringing homeownership to everyone if we don't look like America ourselves?" said Maria Johnson, who has been vice president of diversity, health and work life at Fannie Mae since 1992, in the Business Ethics piece.

Fannie Mae's policies are a fine expression of the type of lending support we would be pleased to acknowledge in our Better World Portfolio. But that's only one criterion. The company also had to look attractive on the Stock Selection Guide and in our personal study of the company.

It did (see SSG below). Although our estimated future growth of earnings per share was in single digits, far lower than the company has achieved in the past, and the company has been facing some tough accounting issues with regulators, prospects for a doubling in value looked good at an upside-downside ratio of 3.1-to-1. We reminded ourselves that double-digit earnings growth isn't necessary for a stock to meet NAIC's performance goal of doubling in value in five years. In FNM's case an expanding multiple in the future from an exceptionally low current price-earnings ratio (below 9) could make that happen.

Its market price has gone nowhere over the past five years, while revenues (defined in this case as net interest income plus guaranty fees), earnings and dividends have grown nicely. The resulting collapse in Fannie Mae's P/E ratio may be discounting far too much. Yes, there are complex accounting issues, rising costs and slowing earnings growth (Value Line is forecasting down earnings for 2005), but there is also solid potential for longer-term growth, value and appreciation. We purchased 100 shares at $67.76 on June 1.

We could well be wrong in our selection of Fannie Mae for its investment prospects. In fact, with expectations for rising interest rates and concern over the company's ability to provide profitable services in such an environment, it's understandable why the company's current P/E is near or at historic lows. Of course, we could very well be right. We'll know for sure in five years.

We won't have to wait that long, however, to tell our children why the company was added to our portfolio. They know already. What's more, subjects like microlending and providing financial support to those traditionally underserved by lenders is now on their radar screens as well. As parents, that's part of the return we're getting on our investment.

Doubling Value Over Five Years, Not Five Days

One of the things we like about being NAIC investors is the freedom it grants us to add stocks like Fannie Mae to our portfolio when they're out of favor. NAIC's performance target doesn't require us to maximize our profits or to worry about how well we'll be doing over the next 12 months; rather, we're simply striving to double our value over the next five years or full business cycle.

That means we don't have to be on today's hot-stocks bandwagon, focusing for example on stocks that carry Value Line's highest timeliness rating. In fact, there's a bit of a safety net in investing in companies like Fannie Mae that aren't in today's spotlight -- their P/Es are lower. If those same companies turn out to have positive growth trends longer term, those P/Es are likely to rise one day and have a powerful effect on stock prices.

If we were investing for best year-ahead performance, would we have added Fannie Mae to our Better World Portfolio? No. If we were investing to maximize our investment performance, would we have added Fannie Mae? No. We added it to our portfolio because we think its prospects of doubling in value over the long term are good. And amid today's world of war and division the company is making an incredibly positive contribution to building a better world, a value we're proud to underscore with its addition. (Editor's note: Again, we remind readers that no investment recommendation is intended. Opinions expressed are solely those of the authors and do not necessarily reflect positions of Better Investing or NAIC.)

Meaningful Lessons

Our adult children are taking more of an interest in what we're investing in and why. The fact that we're investing to help make important things possible, like their college educations, has been important to them all along. But they weren't involved as much in the past with what we were doing as they are now. They know all the stocks in our Better World Portfolio and why we chose them.

Interestingly, they don't give much thought to the investment performance of the stocks we've selected. They just assume they'll all grow in value. After all, Mom and Dad picked them. (How's that for trust!)

What they do think about and comment on is why we purchased the companies. They know how important the whys are to us, how much we believe in what we're doing, and how much that tells them about their parents and what's important to us. Meaningful communication between parents and their offspring? You bet.

It's meaningful in other ways, too. "There's a trend in investors looking for more than profits in the companies they're investing in," says Peter Kinder, president of KLD Research & Analytics. "People are looking at corporations much more carefully than they ever did before, primarily because they're realizing what a huge role these corporations play in their lives.

"A lot of people ask if this isn't the result of Enron and WorldCom and the like," he adds. "The answer is no. The trend was there a decade before those disasters hit. What those disasters caused was institutional investors to look much more closely at what we were researching. But individual investors have shown a steadily increasing interest in what they were holding and why, what goes into the corporate cultures of these companies, what goes into their environmental performance. And I'm very excited about that."

It's easy to sense the passion Kinder has for the subject of social screening, as well as the importance he places on it. "The only way a positive social change occurs in society is with broad participation and support," he says, "and that doesn't mean you have to get out and be an activist and spend every night and every weekend working toward this. It means using the tools that you have, lending support where you can, to efforts to make things better. And by voting with your dollars by investing in socially screened companies or mutual funds that have outstanding records in all social issues, you're doing something positive.

"And perhaps by going a step further and picking up your computer and writing a letter to the corporation about why you're investing or to a mutual fund about a holding that might or might not meet your standards, you're building a basis for change."

Taking Proxies More Seriously

Our experience is having a positive effect on our proxy voting. We've been lax in the past in voting our shares, but now we feel guilty if we don't do so. After all, our words have a hollow ring to them if what we say is not what we do. Even for holdings of only a few shares, we've now committed to voting all our proxies. By beginning to do so, we've also discovered how easily that can be done today for most companies using the internet. We don't have to mail the proxies back. It took us less than five minutes to vote our Target shares recently via www.proxyvote.com.

Members of the Green Futures Investment Club also take their proxy voting responsibility seriously. "We are committed to ethical investing in our personal portfolios," says Jacque French. "We do vote our proxies and advocate for socially responsible investing. We believe that being in the movement for SRI is making a difference. We would like to see Better Investing include information about executive pay compared to workers, independence of boards and auditors, community service, equal opportunity and environmental considerations.

"In other words, we believe a double bottom line is important to the sustainability of our world and that we should all be concerned about more than making the most money. The truth is that you can do both."

Green Futures members look for quality stocks as defined by NAIC, checking out the social responsibility of a company before doing an SSG. In making purchase decisions, members consider a company's corporate governance as well as its record of including all stakeholders (shareholders, customers, employees, the community, etc.) in its grand plan.

Should You Limit Your Universe?

There are two types of criticism directed at socially responsible investing. The first is that investors don't have the right to judge corporations on a moral basis. The reasoning is that corporations are what they are, and they should only be concerned with making a maximum return on the shareowner's dollar.

"My response to that," Kinder says, "is that corporations are legally people, and people have responsibilities to other people in society. I can't start a nuclear waste dump on my lot. I can't do something that would destroy the property values of my neighbor, either legally or ethically.

We have an obligation to evaluate those people and companies and deal with it accordingly. You wouldn't deal with an unethical lawyer or an unethical person; why should you deal with an unethical company?"

The other type of criticism deals with investment performance. If you apply social screens and knock out companies or at times whole industries, you have a much limited universe to invest from. and if you limit your universe you're going to get inferior returns. One of the things the Domini 400 index has done is disprove that notion. it now has a 14-year track record, with results updated monthly and available on its Web site.

Where there is truth to performance concerns," says Kinder, "is where you apply screens that are very rigorous. For example, if you have a very strict environmental screen, you'd end up with a portfolio of nothing but banks and insurance companies, and that's because you can't find out what banks and insurance companies actually invest in. You can get hurt with lack of diversification. Of course, that's true of investing in general, not something limited to the use of social screens."

Most social investors in Kinder's experience are willing to deal in shades of gray. "There's an ironic twist to this," he says. "What I like about social investors is that they're basically realists.

They understand what they're dealing with. But you get those who object by saying, 'Well, if they don't adopt an absolute standard, what good are their standards? What good are their screens?' My response to that is that they're doing their job; they're doing what Warren Buffett does. They're applying their standards, their values, and some companies meet them and some companies don't."

The social issue that seems to be getting the most attention today is climate change and the environment, Kinder says. "The truth is, however, that the issue that really motivates people is the one that becomes obvious when you think about it for a while, and that's product quality and customer service. That's because that's where individuals interact with corporations."

There are a host of informational and educational Web sites at which investors can learn more about social screening and socially responsible investing. In addition, Peter Kinder offers seven tips for becoming "SRI savvy" (see Part 2).

We expect the Danko Better World Portfolio will continue to challenge us in the years ahead. We missed our initial target of having at least five stocks in the portfolio by year-end 2003, but we hope to have all five by year-end 2004. We have one more to go, and one already is on our watch list -- Procter & Gamble, one of the other companies in the Business Ethics feature on the 100 best corporate citizens. We've set December 2008 as "judgment day." We've told our daughters that's when we expect the portfolio to be worth twice as much as we invested in it. If that happens, our daughters will certainly be pleased. Actually, if it doesn't, they'll still be happy. And in either case, so will we, because we'll have left them with more than stocks.

In the end, the message is a simple one. We all can do more with our investing than simply make money. All we need do is add our personal principles for living to those of NAIC. We can't think of a more winning combination.