What is Socially Responsible Investing? Recently, we interviewed Martin Grosskopf,MES, MBA, I nvestment A nalyst for the Acuity Social Values and Clean Environment Mutual Funds.

Toronto Talks: Martin, there has been a great deal of interest from Canadians about where they are placing their investment monies. Yes, performance is important, but many Canadians are asking what types of industries they are investing in. They are asking to be socially responsible in their investment strategies. Yet, many of us do not know what socially responsible investing is?

Martin Grosskopf: Socially responsible investing is the application of additional criteria beyond just the financial ones we use to screen companies. We conduct the financial analysis on a pool of candidates and then we layer additional criteria on top of it, in terms of human rights, environmental, employee practices, or international operations. This gives us a better sense of the issues facing a company that we are analyzing.

The criteria are the main aspect of socially responsible investing, however there are two additional pillars of social investing: shareholder activism, and community investing. Each Fund company will differ in how much emphasis they put on each pillar. We are primarily engaged in the additional screening of companies, however, we are also getting more involved in the shareholder activism, and we intend to become involved in community investing through one of our research providers, Calvert Group. Calvert is considered a leader in community investing.

Shareholder activism means being active in your proxy voting or even initiating votes on particular issues. While corporate governance has become a hot topic for the mainstream of late, social investors have been addressing issues such as executive compensation for quite some time. Social investors have for years requested that Talisman withdraw from its operations in Sudan through their proxy voting activities.

TT: What is Community Investing?

MG: Community investing involves providing a percentage of the funds to local enterprises that may or may not have access to financing via a bank but who are providing a valuable service or product. The investments have high local impact and are expected to generate a market type return, but not much more than that. It is generally a very small percentage of the portfolio. Calvert has been doing this for years and they have considerable expertise in the area.

TT: What is your relationship with your research providers?

MG:We use Calvert Group, based in Bethesda, Maryland for our Global Social Values Fund and Michael Jantzi and Associates out of Toronto for the Canadian Social Values Fund . . Our relationship with these providers is as follows: we present them with candidates that have met our financial screens and they will do the social research and give us an opinion on whether the company is meeting our social criteria..They conduct a full social audit on the company. Both companies have strong expertese in a full range of social issues from the environment to human rights.

TT: So, your list indicates that your fund invests in MicroSoft. You will ask Calvert to investigate Microsoft, they will do an audit based on human rights, employee responsibility, environmental, labour relations, etc, and in the end give them a pass / fail type of grade?

MG: Yes, that's how it works.

The beauty of dealing with a company such as Calvert is how large they are as an organization. As an example, for myself to investigate one company fully from a social perspective could take 4 months, but they have 17 people just doing social research some of whom bring with them senior level experience with the US administration either in policy or technical roles.

TT: What is your role wrt the Acuity Social Values Funds ?

MG: I am the investment analyst that has input into all these funds as well as the Clean Environment Fund. I feed into the stock selections for the funds. We manage the fund as a team on the investment side. The team includes Ian Ihnatowycz?, who is the President of Acuity Mutual Funds and Lead Portfolio Manager, Hugh MacCauley, who is the head of equities, and portfolio manager, , as well as Warren Fenton and David Stonehouse both Portfolio Managers. I basically feed into all of these fund managers.

TT: What are the mandates of the Acuity Social Values Funds?

MG: The mandate of the funds are to invest in companies that we expect will have financial out performance but also meet minimum social standards. Ideally, however they are don't just meet the minimum but are leaders in social performance. Some people call it a triple bottom line performance, where you look at financial and social criteria in investment decisions

TT: The perception of social investing, people think of buying Hemp plants. Where infact is SRI going?

MG: In North America, there was a strong puritan approach toSRI over the past 40 to 50 years. For instance, Mennonites would have applied social criterion to their investments decades ago. Now, it has a much broader scope. Currently, there are 2 trillion dollars of US assets that are invested with some sort of social screen. That represents about 13 percent of US assets under management. In Canada, there is about 50 billion in assets that have some sort of social screen representing 3 percent of Canadian assets under management.

TT: Why are we so far behind the US in SRI?

MG: Partially because the earliest investors were religious investors and their assets were quite relatively large. As well, in the US, a great deal of pension money is directed at SRI. Canada has been a considerably slower partially due to the lower institutional interest Canadians have been fairly conservative in the way we interpret fiduciary responsibility and I would say that most pension and institutional organizations are now actively trying to figure out whether they are allowed to invest with additional screens. Our hope is that they will. The UK has passed new pension legislation that requires them to report on what social criterion they take into account in their investment strategies. Europe is really exploding into taking other screening into consideration in making their investment decisions for their pensions.

We just think it is a matter of time before it happens here. It is both an ethical and moral strategy that people can feel good about but more importantly, it is a risk reduction strategy.

TT: What do you mean by a “risk reduction strategy?”

MG: If you look at tobacco industry, there are huge risks associated with investing in it because it has been proven that it causes cancer. They have already lost a class action suit for about $248 billion about 3 years ago. And there are many more lawsuits to come. So, we can look at SRI from a moral and ethical standpoint, but we can also look at SRI from a financial perspective. And you can make money in tobacco in the short term, but if you look at is a sustainable investment, we think there are substantial liabilities associated with it. So, you need to look at it less from a moral standpoint and more from a risk reduction standpoint. And the simple reality is that traditional financial analysis ignore a lot of the additional criterion that we apply. We think some of these criterion look out for the long term. Genetically modified foods are a good example. It is safe to say that the technical consensus is vague as to whether genetically modified food has a negative health impact. While some companies are basing huge proportions of their future revenues on sale of genetically modified foods the European Union and Japan now do not allow GMF's into their borders. As a result, we think there are significant risks in investing in companies such as Monsanto. We will avoid companies like this for investment purposes.

TT: Are you suggesting that by going with SRI's that you are avoiding lawsuits?

MG: Yes, we are trying to avoid it. But there is not yet a good body of analytical research that allows us to quantify just how effective the additional criteria is at avoiding these financial risks. But this will change especially once the institutional investors get involved, as they will drive more detailed research The academic reports have certainly been picking up in the issues. The regulators such as Environment Canada are also interested in SRI as a way to meet their regulatory objectives. SRI will not take over investing, but it will be a bigger part of everyone's investing.

TT: What are some of the myths of socially responsible investing ?

MG: Performance has been a big myth. There is an index in the US called the Domini Index. It basically took the S&P 500 and applied additional SRI criterion. The 400 companies that passed have been tracked since 1991. The return until December of 2001 was actually statistically insignificant to the S&P 500 indicating that you are not giving up anything by applying social screens.

Myth # 2 is that you are taking on additional risk with SRI. Yet, on a risk adjusted basis (adjusting for underweighting of the resource sectors for instance which have greater social concerns) the Domini Index, still comes out about equal to the S&P 500. The conclusion I come to is that if you look at an index of companies that have been screened for socially issues, you are not giving up anything. I'd love to be able to say that the Domini “blew away” the S&P 500, but I'm very comfortable saying that it matched it. Any outperformance is just gravy!

Myth # 3 is that on the mutual funds side that the SRI has not performed well relative to their benchmarks. I've got a number of research studies that show that the SRI funds perform as well as any of the Canadian mutual funds. The authors didn't find that the SRI criterion was changing the return profile of the funds.

Morningstar ratings in the US show that the SRI funds are getting more 4 and 5 star ratings relative to the other mutual fund counterparts. If you look at our own funds, the Clean Environment funds performed exceptionally well for most of the 90's and then fell off. The Social Values, which were launched in October 2000, have done very well.

TT: What type of industries do your funds embrace?

MG: Our intent is to be broadly diversified. We think that short term returns are attributable largely to regular portfolio management and not from SRI criterion.

So, we are pretty broadly diversified, but we are focused in general on the early cyclicals. We have had consumer product companies overweighted, the financials overweighted, and we have emphasized select tech companies, which is not the big name ‘high tech' companies, but rather, undervalued industrial technology companies. We have also been increasing the resource sectors recently. In the Canadian funds, the oil and gas is 10 percent,mining is 4 percent and forestry is 2 percent. An example of a Canadian forestry company is Tembec which has one of the most progressive environmental programs in the industry. In oil and gas, we've invested in Suncor, which has invested greatly in having its emissions reduced significantly. Financial services represent 22 percent of the Canadian fund and industrial products represent 29 percent of the fund.

Another area of interest is home building which is a theme for the fund. As you know, homebuilding has increased significantly in Canada.

TT: What about technology investments?

MG: We are not that bullish on the big technology investments like Cisco and Nortel. What we focus more on are smaller to midcap companies that are often more industrial technology type firms. An example of a Canadian firm that was added recently is Wittke which is an industrial products company. They do all the design and manufacturing for the bodies of the trucks in the waste management industry. They get the chassis from Volvo or Freightliner and then add the value added features of the truck. For instance, they have a mechanical arm that will pick up the trash electronically, thus eliminating one of the most expensive parts of waste management- labour. They have a huge contract with Waste Management and are trading at a reasonable valuation.

TT: How long do you anticipate holding these companies?

MG: With respect to the homebuilders theme, as interest rates increase, housing purchases will decline, so we will reduce our holdings in this sector. We will move more into the mid cyclicals like the heavy industrials and eventually look for later stage cyclicals such as chemicals which still pass our criterion. Ideally, we have a core number of companies that are benefiting from a secular trend which we will hold throughout the economic cycle.

TT: I noticed that Ballard power is not part of the Canadian Social Values fund.

MG Correct, however, it is in the Clean Environment fund. This fund is focused entirely on an environmental theme. That fund has more of a technology bias as we are looking for some process or technology that will benefit from the environmental theme. At the same time, the fund is diversified into companies that are the best in their sector for an environmental standpoint in order to ensure proper diversification in the portfolio. The reality is that the number of environmental companies in Canada that are public and are profitable is small. Primarily, we will look at exciting small to mid cap companies that have a solution to environmental concerns. The Acuity Social Values Funds have more of a large cap bias. Partially this is due to the broad social research that has to be done on the companies as well as the fact that the Fund are designed to be core holdings. The Clean Environment is more of an all cap type of approach.

TT: What are some of the success stories of the Social Values Fund?

MG: Homebuilding was a big success. Having bought into this early was a good strategy even before the Sept 11 crisis. Homebuilders were trading at very compelling valuations and continue to look relatively good even a year later.

TT: What were some of the nightmare's?

MG None. To be honest, with these funds, we've not had a blow-up. Since we launched it in October 2000, we missed the dot com bomb.

TT: If everyone became a Socially responsible investor, what are the international ramifications of this type of investing?

MG You are investing in companies that are hopefully improving environmental and social conditions around the world. What you would see is the development of international labour, environmental and human rights performance and reporting standards If you had more companies focused on being socially responsible, this would become the basis for doing business. In other words, if your company did not comply with basic standards of operation, then you would be at a competitive disadvantage. Corporate social responsibility would just be part of doing business and not be considered an additional burden on the company. That's what we hope the end result will be. A better world for all of us.

For more information regarding SRI, you should speak with your advisor specifically.

This interview was conducted by John Klotz., B.A., CFP., CLU., CH.F.C., RHU

John is Vice President - Financial Services of LMS Prolink Ltd. You can reach him at johnk@lms.c a or phone (416)-595-7484 ext. 305.