Socially Responsible Hedge Funds: An Oxymoron?

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The New York Sun

Zoe Van Schyndel and her partner Paul Soo plan to start up two socially responsible hedge funds early next year. Oxymoron? No, these managing directors of StarFish Capital Management intend to launch both a large cap and a small cap fund that will invest in companies satisfying a number of ethical requirements, while at the same time earning attractive returns for investors. Is this possible?


Ms. Van Schyndel claims it is, citing the success of several socially responsible investment (SRI) mutual funds, and the out performance of the KLD/Domini 400 Index, which she helped create.


The index, which tracks a universe of companies selected for their environmental, governance, or community attributes, has slightly outperformed the S &P 500 over a 10-year period.


In the past year it has lagged, which is somewhat astonishing, given current-day scrutiny of corporate malfeasance. One would expect that investors who were blindsided by the Tyco and Enron affairs would be especially drawn to companies viewed as model citizens.


Who are these elite corporations? Among the top ten KLD/Domini holdings as of the end of September were Microsoft, American International Group (oops), Johnson & Johnson, JPMorgan Chase, and Merck (another oops). Clearly, you have to be pretty light on your toes to select companies that demonstrate praiseworthy corporate behavior, and that can reliably add to a winning portfolio.


Ask Jane Siebels-Kilnes, head of Green Cay Asset Management in the Bahamas. One of the few SRI hedge fund managers extant, she runs several funds totaling about $250 million that employ values-driven guidelines, and she has done quite well.


For instance, the Siebels Technology Fund has accumulated a 31% gross total return since inception in 1999, compared to a loss of about 8% for the FTSE World Series Total Index. Ms. Siebels-Kilnes worked for Sir John Templeton for many years, and has adopted a number of his investment philosophies.


Mr. Templeton encouraged her to avoid the herd mentality by finding a unique style of investing, and she has. Rather than follow the guidelines set out by SRI indices such as the Domini, Ms. Siebels-Kilnes tries to identify companies with what she calls “positive values.”


Yes, she avoids alcohol, tobacco, and hand gun producers and other obvious “evildoers.”


However, she is most keen to find companies that treat stakeholders extremely well. That means having good employee and community relations, good governance (stockholder relations), and a positive environmental record.


In her search Ms. Siebels-Kilnes employs ethics professors from universities around the globe. Her team visits companies all over the place looking for those truly dedicated to a common mission.


Does it help? Well, she’s proud to report that she was short Enron, Tyco, Dynergy, and Worldcom, all at the right time, and for the right reasons.


For example, one of her foreign professors was on to the poor economics of an Enron plant in India, which led to a broader examination of the company, and ultimate short sale.


On the positive side, she bought stock in a supermarket chain in Colombia that was funding scholarships for the children of its employees. The good will generated by the program significantly cut turnover at the company, boosting gross margins. Another win.


The message? Good corporate citizenship leads to excellent decision making, and long-term prosperity.


Of course, other factors come into play for Ms. Siebels-Kilnes. She uses momentum statistics to identify buy and sell points, as well as other traditional management tools. She is flexible, and also practical.


She cautions other SRI investors from relying too heavily on the Domini index, which has tended to overweight the technology sector, mainly because so many companies in the field are new, and not well-known. In other words, they haven’t had a chance to mess up yet.


So how does an SRI newcomer like Ms. Van Schyndel expect to bring investors to her fund? Are there many people who care about investing in worthy companies? Evidently there are. An organization called the Social Investment Forum estimates that SRI assets have nearly doubled in the past five years, and now top $2 trillion.


Not all this money is invested to the same end, needless to say. One person’s sense of social excellence clearly may differ from another’s. For example, there are apparently Catholic and Islamic funds of funds up and running; we just bet they don’t have identical portfolios. However, there are four mainstream classes of companies with universally applauded attributes.


The first category includes companies that are viewed as advancing positive societal causes, such as those that make recycling machinery or invest in alternative energy. The second group eliminates clear-cut “bad guys” such as companies selling cigarettes.


The third subset seeks companies with exemplary governance records. And the final group is composed of companies which answer community needs such as affordable housing or minority employment.


It is all rather complicated, however. For example, there is probably no company doing more investing in alternative energy programs than BP. BP is also quite sensitive to environmental issues.


However, it’s an oil company, for heavens sake. Most SRI types wouldn’t like to see their money supporting outfits that are seen as routinely spewing toxic materials onto sandy beaches, not to mention seagulls.


Ms. Van Schyndel acknowledges that there are many grey areas. For instance, she would likely eliminate oil companies from her portfolio, for the reasons just cited. In a period such as today when energy stocks are doing well, she would hope to participate through more acceptable natural gas stocks.


It is because of the complexities presented by many large companies that Starfish may open a small cap and large cap fund simultaneously.


For the first-time SRI investor, large cap companies may be the way to go, offering somewhat less volatile performance.


For those seeking “purer” plays, however, small caps make sense. StarFish Capital hopes to launch each fund with around $20 million.


The greatest challenge for a newcomer to the field, according to Ms. Siebels-Kilnes, is convincing the world that ethics can produce alpha.


That is, that the best tool by which a manager can create above-average performance is by adherence to “green” guidelines. In the wake of all the recent corporate scandals, the case has gotten a lot clearer.



Ms. Peek is a former managing director of Wertheim Schroder, now a part of Citigroup.


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