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Introduction To Values-Based Investing

When we talk about sleeping well at night or SWAN, it usually means finding a stock that will have stable earnings and lower risk. There is another type of SWAN that involves giving our conscience a break and investing according to our values.

Not to be confused with value investing (where undervalued stocks are sought for acquisition), values-based investing is when investments are sought that reflect an investors moral values. This manifests itself in various forms:

Investing to reflect religious beliefs - both to partner with companies that share religious values and to avoid companies that market a product or service contrary to religious beliefs.

Promoting the environment - avoiding companies that harm the environment or partnering with companies that have favorable environmental policies.

Promoting fair labor practices - avoiding companies that have harsh working conditions or in some way exploit their workers and partnering with companies who's labor practices you agree with.

Promoting fair management policies - avoiding companies whose management policies you do not agree with and promoting companies who have policies you like (think of the recent Wells Fargo scandal and subsequent California and Chicago/Illinois banning of relations with the bank)

Promoting health - avoiding companies who's products or services are detrimental to peoples health and promoting companies who's products and services promote health.

And ultimately - promoting a favorable society - avoiding companies who detract from your ideal society and promoting companies that share your vision for how society should be.

Values-based investing is know by many names - Socially responsible investing (SRI- which can also stand for sustainable, responsible and impact investing) is often used as a name for values-based investing. Another term is Environmental, social, and corporate governance (NASDAQ:ESG) which is sometimes used to denote the criteria or screening used. Ethical investing, sustainable investing, green investing, responsible investing, and community investing are also used.

Values-based investing typically adds another dimension to investing decisions. Prior to evaluating companies for their underlying value, earnings potential, and potential returns, a screen is used to avoid companies that do not share your values. This adds complexity, effort, and sometimes deep research to determine the practices of a company you are considering for investment.

Those who choose to ignore values-based investing and focus solely on maximizing returns on their investments I feel are in the majority and I understand where they are coming from. They have an obligation to provide for themselves and their families and they want the best returns on their investment. They want to avoid adding in complexity that is time consuming, costly, and often involves soul searching and defining grey areas while judging where to draw the line on what is acceptable. They let the law decide what is right and wrong and invest in companies that operate legally. For whatever reason, they don't feel that their investing should try to combat the ills of society not yet covered by the law.

However, those who invest according to their values show concern for the effects of their investments and are willing to forego potential earnings for themselves in order to clear their conscience and promote their ideals.

My own investing strategy has evolved to include values-based investing over time. I started out investing in vanguard mutual funds that had no rules on avoiding any potential investments. As I looked through the list of companies that these funds invested in, I saw a few companies that made me uneasy. The detrimental effects to health and society of alcohol and tobacco products disturbs me. I began to realize that I needed to buy individual stocks instead of mutual or index funds so I could avoid these companies. Although buying a stock on the secondary market does not directly give a company money, receiving dividends from that company certainly come from earnings received from sale of their products or services. Making money from people buying cigarettes or alcohol screamed against my values.

In the course of my studies in biology, I learned that Philip Morris owns the patent on a gene in the nicotine synthesis pathway that controls the amount of nicotine produced in the tobacco plant and can legally manipulate the amount of nicotine produced.(link) Studying the Massachusetts history of testing for nicotine content in cigarettes, I saw that the amount of nicotine had been going up in cigarettes over time (link). This further infuriated me against tobacco companies that know the detrimental health effects of their products and then go to work to promote their addictive properties. I understand that recently big tobacco has pushed for lower risk products (link), which might be a positive development, but not nearly enough to make me comfortable investing.

My values have developed and are developing over time with experience and extensive study. I've added to my list of companies that concern me enough to avoid investing in them. Soda companies have marketing practices I disagree with. Companies or real estate investment trusts in the gaming industry promote addictions that damage financial lives. Many US Oil companies buy oil from Saudi Arabia, and some of the money from that purchasing trickles down to terrorists. (link) (You can see which companies import oil from the Persian gulf here (link).) Companies that produce military weapons are a grey area for me that I currently avoid. Although I believe in a technologically and strategically superior national defense, the current foreign policy of the United States uses these weapons in a manner I disagree with. My position on this may change depending on who gets elected to public office and what decisions they make, but that's not likely to happen this presidential election cycle.

Government or municipal bonds allow for funding of whatever that entity decides to do with it. I can't think of a person that completely agrees with how the US government spends money, but almost everyone wants certain things the government does to be funded. I would like to have more choices in mutual funds that invest in municipal bonds as buying the bonds directly takes a large investment and is more difficult to buy and sell. There are certain states municipal bonds that I would like to avoid but haven't been able to.

Another way to approach values investing is to promote change internally as a shareholder. One needs only to look to the annual shareholder meetings of Philip Morris to see how nurses that own one share are able to lambaste management for selling a product that damages health so severely.(link) Many times this avenue is ineffective and pleas for change fall on obstinate or uninterested ears. Activist investors who have a lot of money to throw into a cause can have more clout than a lower capital investor.

Where values investing can get complicated is deciding where to draw the line on what is acceptable to you. An example will assist us here. I currently avoid investing in tobacco companies, but they are not the only company involved. Trucking companies distribute cigarettes, retail outlets such as gas stations and grocery stores sell them, and some companies allow or facilitate their advertising. I tend to only avoid investing at the first level - at the actual producer of the offending good or service. Trying to nail down exactly which trucking companies ship cigarettes is difficult and most ship various benign products in addition to cigarettes. Some REITs lease distribution warehouses to tobacco companies. The larger a company is, the more interwoven it likely is to some companies you may be avoiding. I've heard of an 80/20 rule that seems somewhat reasonable. (link) If 80% of the business a company does is acceptable to you, its ok to invest. Tobacco, alcohol and soda are so interwoven into our commercial system it seems impossible to avoid all companies that interact with them. A good example for me is a retailer like Walmart (NYSE:WMT). Im sure less than 20% of their business is tobacco and alcohol. They would be an acceptable investment according to the 80/20 rule.

Some mutual funds have investing rules that try to reflect widely held values. I wanted to compare some of the returns of mutual funds that practice values-based investing to the S&P 500 and to a mutual fund that primarily invest in the stocks I try to avoid. Below is a 10 year price chart of a catholic based values fund AVEDX(Ave Maria Rising Dividend fund) that is "screened to eliminate any company engaged in abortion, pornography, embryonic stem cell research, or those that make corporate contributions to Planned Parenthood.(link)" (note: Ave Maria funds do invest in alcohol companies and large oil importer companies), a larger values-based investing fund - Calvert Equity Portfolio CSIEX, a values-based index fund - DSI that closely matches the S&P 500, Vanguards VFTSX, andVICEX - USA Mutuals Vice Investor, a fund that "select(s) well-performing stocks of tobacco, alcohol, gaming, and weapons/defense companies"(link) to the SPY ETF.

Source: Yahoo Finance

Ticker Yield Expense Ratio
AVEDX 1.29% .92%
CSIEX .25% 1.07% + 4.75% max sales charge
VICEX 1.04% 1.48%
SPY 2.01% .11%
DSI 1.50% .50%
VFTXS 1.75% .25%

If you can't find a mutual or index fund that perfectly matches your values, or they all seem to have too high of expense ratios for you, then looking at the holdings of one that as closely as possible matches your values can save you some leg work in excluding or including companies. Working from their holdings, you can then add in any other exclusions or inclusions you want and pick the best value stocks you can find. Mutual funds charge fees and those fees increase as you add complexity. Values-based investing adds another layer of complexity that can cause increased fees for these funds. There is a risk these funds focus more on what not to invest in and have little skill in actually creating good returns on investment, although as you can see from the above chart, AVEDX and VFTSX did beat both VICEX and the SPY in price increase over the last 10 years.

A few of the other funds in the expanding world of value-based investing are Calvert, Neuburger Berman, Domini, Ave Maria, the ETF KLD, Eventide Gilead (MUTF:ETGLX), Parnassus (PARWX, PARMX), and a bond fund TSBRX. MSCI even rates individual stocks and bonds on an ESG score from AAA (BEST) to CCC (worst) (link). According to the Forum for Sustainable and Responsible Investment assets invested using SRI strategies were $7 trillion in 2014 or one out of every six dollars managed professionally. There are 181 U.S. mutual funds and 39 ETFs that practice SRI. (link)

Impact investing is a new an emerging area where investors strive to create social or environmental change with their investing while still seeking a profit. An example of an impact investing idea that many signed on to was the Algae Biofuel business. The goal was to make a profit, reduce importation of foreign oil, make a carbon neutral oil, and create jobs in the USA. Unfortunately, the major players in the space - Solazyme (SZYM now TVIA) and Sapphire energy have been transitioning to the nutraceuticals market as the depressed price of oil has been making the economics of their R&D difficult.

I stick to individual stock picking at the moment to guide my values-based investing as no mutual fund I have found exactly has the exclusions and inclusions I'm looking for. It saves fees and I enjoy the challenge of picking stocks. In fact, values-based investing is what brought me to individual stock purchases in the first place.

I think values-based investing is worth the time to explore, I realize many do not feel the same. Ultimately it helps me sleep well at night and I enjoy my efforts to combat ignorance of the impact of companies actions and to do something to promote my values. The challenge is to still create decent returns for myself. Tobacco stocks like MO and military weapons producers like LMT seem to have the highest long term returns in the large cap market, so my challenge is to try and at least beat the S&P 500 index without investing in these companies.

What is your story regarding values-based investing? Do you avoid the headache altogether, choose a mutual or index fund that matches your values, or revel in the challenge of individual stock picking coupled with self chosen value-based screens?

Disclosure: I am/we are long WFC.