INVESTMENT & ECONOMIC ANALYSIS
SOCIAL TOPICS: INVESTMENT & ECONOMIC ANALYSIS
Puncturing Our Balloon
Published, June 1999
These are glory days for social investors. Over almost any long interval in the past five years ending March 31st, many have outperformed the most common benchmark, the Standard & Poor’s 500 Stock Index. This is all the more remarkable because the S&P itself outperformed approximately 70% of the institutional managers in the country in 1998. USTC social portfolios have enjoyed a similarly good run.
Furthermore, the media has rediscovered social investing, some concluding that one can do better with socially responsive portfolios. How times have changed!
Why have social funds fared well? We need to know, for in these greater returns there may be risks.
The best performing stocks have been the largest, highest quality and fastest growing companies. Indeed much of the superior return of the S&P 500 index last year came from just the fifteen largest stocks. In the past, such concentrated outperformance from a handful of large companies would have been a problem for social investors because many of the largest companies either were weapons contractors or had business ties to South Africa. Today however, social portfolios can and do have more large cap stocks as core holdings.
Despite this change, a typical social portfolio is still likely to have smaller companies on average than one without social screens. In order to offset this bias, many social funds have doubled their bets on the very largest companies that they deem socially acceptable. Fortunately for social investors, these companies proved to be the market’s leaders. For example, both major social index-like funds recently held about 8 percent of their assets in super-performing Microsoft, and only ten names accounted for almost 35% of these funds’ market value. Such concentration, however, has risks. Do we now need to brace ourselves for periods of mediocre performance, if these dominant companies lose their luster?
For active social managers like ourselves, there were other contributors to superior performance. The natural biases of social portfolios helped: growth dominated value, high environmental impact sectors like energy and basic materials trailed. We also made some good choices by emphasizing stocks over bonds, and US exposure over foreign. Faced with a deflationary environment, we also favored companies with pricing power.
Could this favorable environment change? Yes, if worldwide economic growth resumes, thereby reducing investment risk, raising commodity prices from their troughs, and stimulating a broadening of activity outside the United States. This in turn, could lead to a reallocation of capital to those areas of the global economy most likely to benefit from the recovery, many of which are underrepresented in today’s social portfolios. Already, in April and May, some social funds trailed the S&P 500.
It may therefore be time to exercise judgement and address traditional concerns about valuation, and to diversify and manage risk, by redeploying well-found gains into areas of new opportunity. Perhaps it is time to hold not just large growth companies but also reasonably priced companies with good fundamentals. Some may be smaller, in more cyclically sensitive sectors or foreign, including in emerging nations. Fortunately, many reasonably priced, high quality companies are available because the market’s rise has been so concentrated. The average company in the S&P 500 was up only 4.4% in 1998 even though the index was up over 28%. By the old rules of what constitutes good value, long term opportunities remain plentiful.
Nothing should keep social investors from evaluating these important changes: there can still be good value in what we value for good. — Stephen Moody
Stephen Moody is a senior portfolio manager, and serves on Walden’s Social Planning and Policy Committee.
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