SOCIAL TOPICS (Archive): INVESTMENT & ECONOMIC ANALYSIS

Published, Fall 2001

       By Geeta Aiyer

       Can social investors be value-style investors? That is, can they participate in stocks of companies and industries that are out-of-favor and controversial? Historically, this has been difficult because social screens have eliminated more companies from industries in which you would expect to find value stocks.

       However, by creatively addressing social issues, broadening value parameters, and using quantitative techniques for portfolio risk management, we can create value portfolios that more than hold their own, on both social and investment merit.

       This is important to do, since diversification along growth and value dimensions is vital, as the current market environment has shown. Because value stocks offer attractive returns through the cash flow generated from ongoing operations, investors can hold them as self-sustaining long-term investments. In contrast, growth stock investors get most of their return by selling to others at higher prices, a challenge in some market environments.

       It is particularly important for social investors to seek out such diversification because, without a consciously added value component, their portfolios are apt to be skewed towards growth style investing.

       Over 50 percent of the market capitalization of a value universe such as the Standard & Poor’s BARRA Value index is screened out by comprehensive social criteria. For a growth universe, the comparable figure would be roughly 25 percent and for the market as a whole, about 37 percent, leaving even a core portfolio with a significant growth tilt.

       Social screens disproportionately affect certain sectors. Over 70 percent of such industry groups as energy, materials, utilities and industrials are screened out, adding up to about 30 percent of the value index’s capitalization. Thus not only is a significant portion of the value world not available for purchase, but as is the case with social investing in general, the most inflation- and economically -sensitive sectors are affected most.

       Companies burdened with significant lawsuits or liability claims, another category of out-of-favor stocks, are often ruled out by social concerns. While tobacco companies, asbestos manufacturers, and their ilk appear to be on the verge of bankruptcy, a contrarian manager may find value in their turnaround potential.

       So, do social value investors stand a chance? Our experience shows that they do, but it takes some effort. On the social side, challenges come in research and advocacy. Researching the social record of many companies in the value universe proves to be complex. While egregious violators of environmental or human rights standards can be identified, it is difficult to get detailed contextual information to make judgment calls on the relative performance of companies with mixed records. Screening thresholds, therefore, may need more flexibility than in core or growth oriented portfolios.

       In high-impact sectors such as chemical manufacturing , we have to fine-tune our ability to identify and invest in the “best of class” companies within a value context. This enables us to invest in troublesome sectors, and engage corporate management in discussion about improving their records. It requires reexamining traditional notions about the trade-off between screening out companies versus owning and influencing them. As Dan Tarlas of Asset Consulting Group of St. Louis, Missouri, says, “My clients feel it is important to uphold strict standards of social conduct for most of the portfolio. But they also recognize that active ownership of some problematic companies may be the most effective strategy for fostering positive corporate change.”

       On the investment side too, we must be creative. We work within the confines of the value stocks available to us, and then go beyond, to smaller names and some liquid foreign companies (ADRs). And we take special care to monitor and manage risk factors, to ensure that the “value” quality of portfolios is not compromised. The result is robust, diversified value portfolios that are made up of well-managed companies making desirable (albeit unglamorous) products, but which are out of the limelight, often in overlooked niches of the economy.

       Indeed, value investing for investors with values is a viable investment option.

Geeta Aiyer is President of Walden Asset Management and also serves as senior portfolio manager.