Whats the painful and sometimes brutal truth about being a socially responsible investor or any investor for that matter? Its hard work.
When we were kids, what did we want to be when we were growing up? We all know what we ideally wanted to be as kids, a star athlete, a musician, pro poker player, actor or actress, model etc…but what kid in their right mind wants to be a professional investor? Well, I was one of those unusual types who should have been guided to counseling early on because I did want to be a professional investor. The graphs and stock tables in the Wall Street Journal fascinated me early on and that fascination remains to this day. But this is not an article about a childhood gone awry but a glimpse into the single minded vision that it takes to be good at most anything, including investing.
To excel at investing means to devote oneself to the prospect of focusing day in and day out on the investment process. What am I doing right? What am I doing wrong, and why? Its an internal process of identifying internal strengths and weaknesses as much as it the search for the undervalued asset. We all make mistakes at one time or another, including major mistakes but in the long run did we accept them as mistakes and learn from them, or do we remain in denial and continue as business as usual?
We probably all know investors who have this continual habit of buying near the top when their confidence is high and selling at or near the bottom when their confidence is in panic. For this reason alone one should really be looking into the mirror of themselves and determining whether they should be managing a portfolio for themselves.
For individuals and organizations who conduct their own investing, they must realize they’re in competition with others who have a single minded devotion to excelling in investing and are happily, even gleefully devoted to their profession.
Any investor, be it a pro or an do-it-yourselfer can run a hot hand for a limited period of time and delude themselves into being the new Master of the Universe. But what will it take for the successful investor to transcend short term progress to long term success? Its really simple as are most things in life, it boils down to limitless learning and plain hard work. When we were 20 something years old, we thought we knew it all. Nowadays for each nugget of knowledge I realized there remains a mountain of educational boulders waiting to be tapped.
To be continued……….
Be careful out there
Brad
No positions
It wasn’t supposed to be this way, the Double Dip Recession and inevitable Deflation were a sure thing, but today’s Industrial Production figures of growth of 1% in July versus the consensus of .7% make want to give you pause if you’re loading up on Treasuries. The figures were led by a big 9.9% surge in motor vehicles, the trend in vehicle production is the most since 1984 while year to year PPI growth is the greatest since 1998.
While this data is very good news for equities its quite bearish for Treasury bonds which are probably leaning too much to the side of buying exuberance.
Consider the following charts from SentimenTrader.com, all three show far too much bullish sentiment to make a potential investment profitable. Investment profits are very seldom made when sentiment is so extreme as the data suggests it’s likely wiser to be a seller rather than a buyer.
These remain very uncertain times but we feel its in error to chase strength, let any market correct itself where you can make your buys on your terms not the market’s.
Allow me to put this another way: With the yield on the 10-year Treasury now at 2.58% it has a P/E (Price divided by Earnings) of 38.7 which is quite close to the bubble era for the NASDAQ in 1999. The current P/E of the S&P 500 is now 12.
Be careful out there
Brad Pappas
With the economy fluctuating between a glass half full one week and bone dry the next we continue to focus on Value and special situations based upon our equity model. For all practical purposes its impossible to predict where the economy will be in a year, but we do know that this period in our history corporations have rock solid with frequent over capitalized balance sheets (lots of cash, little debt) while the consumer continues to de-leverage from decades of over consumption (which will take years).
Value continues to be exploited in the markets as one of our long term holdings Sports Supply Group has been acquired by private equity firm ONCAP LP, shareholders will be receiving cash in lieu of stock. This marks the third holding of ours in 2010 that has either been acquired, subject of a hostile takeover or considering sale of the company. Asset rich companies make attractive targets since the cash on the books is quantifiable and frequently the underlying business can be acquired for little or nothing. Frequently these companies are the targets for Value investors who love nothing more than predictable and boring companies in sleepy industries with hairless balance sheets.
Present market weakness has pressured the price of Audiovox symbol VOXX to an excellent entry point here at $6.55. VOXX has approximately $330 million in current assets and $118 million in total liabilities which net to $212 million but the market value is $148 million. The $64 million dollar difference with 18.5 million shares outstanding or $3.45 per share is a rock solid Margin of Safety to the patient investor willing to wait for the value to move in excess of the balance sheet. The stock holds the potential for a 50% or more rate of return assuming the balance sheet remains intact.
VOXX has been around since 1965 and makes some of the coolest audio equipment in the world but it isn’t always profitable. Earning expectations for 2010 are in the .35 per share range but the estimate is from only one analyst.
Products are marketed under the Audiovox brand name along with other brands such as Acoustic Research, Advent, RCA, Jenson, Road Gear and Spikemaster.
One aspect that caught our eye was the list of investors who own significant stakes in VOXX: Seth Klarman of Baupost Group, George Soros and Irving Kahn.
We expect owning shares of VOXX to be a long term investment, investors should have a multiyear expectation. It is the type of stock that you could rest easy when you go on that multi-year sabbatical to the Amazon.
Others may want to wring their hands with the potential for deflation, however with investor angst so high at the moment reflects that much of the deflation debate may be baked in the cake of the market for the interim, hence the potential for significant values is quite good.
Be careful out there.
Brad Pappas
Long VOXX
As an investment manager with Rocky Mountain Humane Investing (www.greeninvestment.com) the most common question we hear from potential clients is “and advisor told me that socially responsible investing isn’t profitable” versus unscreened portfolio management. In general the advisor providing the dogmatic opinion does not offer any foundation for their opinion but this is their chance to influence the potential client especially if they cannot offer an SRI option for the investor. Unless you have a few arrows of your own in your quiver you may be quite likely shrug your shoulders and resign yourself to an unscreened portfolio versus a clean portfolio.
Probably due to the fact that I’m over 50 now with a repellent view of hyperbole and unsubstantiated opinions I have been uncomfortable with opposite view as well: socially responsible investing improves rate of return. It has been my view based upon empirical experience of managing SRI portfolios for 20 years that SRI is not a significant determinant of investment performance. SRI is a highly subjective practice where investors can have divergent opinions on industries and companies. There is not unified screening standard amongst the SRI industry, each firm or fund makes their own decisions on screening criteria. While some funds screen for only 3 or 4 issues there are other funds that screen over a dozen.
Practitioners of SRI may draw attention that investors always assume a given level of risk with any equity investment but that the risk premium associated with SRI is less. Case in point the risks associated with Tobacco, Asbestos or BP and the Gulf oil disaster. However in my 20 years involved with socially responsible investing, screening stringency is often a matter of interpretation as BP was considered Best of the Lot for many years for funds that desired petrochemical exposure.
Let’s take a look at some of the academic studies that have touched upon the issue of the factors of SRI performance:
- Moskowitz Award winner, John Guerard, Jr., director of quantitative research at Vantage Global Advisors, examined the returns of Vantage’s 1,300 stock unscreened stock universe and a 950 screened universe (The screens eliminated companies that failed to pass alcohol, gambling, tobacco, environmental, military, and nuclear power). He found “that there is no significant difference between the average monthly returns of the screened and unscreened universes during the 1987-1994 period. The “unscreened 1,300 stock universe produced a 1.068 percent average monthly return during the January 1987-December 1994 period, such that a $1.00 investment grew to $2.77. A corresponding investment in the socially-screened universe would have grown to $2.74, representing a 1.057 percent average monthly return. There is no statistically significant difference in the respective returns series, and more important, there is no economically meaningful difference in the return differential.”
Guerard’s conclusions are reinforced by other works:
- “Socially Responsible Investment: Is it profitable” Dhrymes, Columbia University July 1997 June 1998.Dyrymes concluded that: “that by and large the Concerns and Strengths of the KLD index of social responsibility are not consistently significant in determining annual rates of return.”
- Socially Responsible Investment Screening Strong Empirical Evidence For Actively Managed Value Portfolios. June 2001, revised December 2001 Stone, Guerard, Gultekin, Adams.“No Significant Cost” means no statistically significant difference in risk adjusted return”. In addition, they surmise that “the conclusion of no significant cost/benefit is not just a long term average. It has remarkable short term consistency!”
In my opinion this report presents a balanced view in that they concluded that the during the time of the study 1984-1997 the stock market rewarded the growth oriented style and that the performance of SRI investments could become “brittle” if markets were to become risk averse and adopt a more Value oriented style……….a remarkably accurate presumption!
Could the performance of SRI funds which have exceeded or lagged their respective benchmarks be in part due to size (average capitalization from micro cap to large cap) and style (Value or Growth)?
Fama and French of Dartmouth University examined the annual rate of return and beta (volatility) of an unscreened universe of Growth vs. Value from 1928 to 2009 by dividing stocks into ten deciles (groups) based on book-to-market value, rebalanced annually and found that Value had the lower risk while Growth had the higher risk. In addition, they found that the highest book –to-market stocks exceeded the return of the lowest book-to-market by 21% to 8% on average. Stock valuation was as significant factor in the Fama and French study where the cheaper the equity valuation the better the return.
Market Cap size was important in the Fama and French study as well (1992). Market cap size showed a significant edge to small and micro cap equities on a monthly basis. *Monthly returns for the smallest 10% of equities were 1.47% versus 0.89% for the largest decile.
It is our contention that there are attributes that could account for performance to equities other than social profiles and that concurrently a portfolio of socially screened equities with the highest book-to-value ratios could exceed comparative benchmarks largely due to valuation metrics and capitalization size. In a case of pure cherry picking the monthly rate of return smallest market cap and lowest book value to market price was 1.63% versus .93% monthly for largest market cap and highest book value to market price.
I tested this theory using data supplied by the Social Investment Forum and Russell Index regarding the 10 year average rate of return for socially responsible mutual funds versus their respective benchmarks trends do emerge.
Data as of June 30, 2010
Benchmarks
- Russell Mid Cap Value Index was the top 10 year performer +7.55%.
- Russell Mid Cap Growth Index returned -1.99%.
- Russell 2000 Value returned +7.48%
- Russell 2000 Growth Index returned -.92%
Equity Large Cap performance (information provided by SIF)
- 4 mutual funds show positive 10-year average annual rates of return:
Calvert Social Investment Equity +0.14% (Growth)
Neuberger Berman Socially Responsive +3.18% (Value)
Walden Social Equity +1.46% (Value)
Parnassus Equity Income +4.65% (Value)
Equity Small Cap performance
- 2 mutual funds from one mutual fund company showed a positive 10-year rate of return.
Ariel Appreciation +6.16% (Value)
Ariel Fund +5.62% (Value)
Disclaimer: While the sample size of SRI fund performance is very small. I gleaned data from only the profitable SRI funds for the last 10 years. The SIF forum does not show fund performance information for funds that have closed, merged or liquidated. It would be a safe presumption IMO that funds that no longer exist were weak performers since money will flock to where it’s treated best. Plus, hedge fund performance data was not available on the SIF site.
The results do fall in line with substantial academic works (Fama and French, Lakonishok) and it is possible that SRI performance should be viewed thru the lens of Value/Growth and Market Cap size.
A logical question that must be asked upon reading this might be: “If small market cap and low valuations are the sweet spot for investing, then why are there so few funds or managers focusing on this strategy?” Not to be obvious…………ok, well lets be obvious: The small cap / low price to BV tends to be the focus of many private portfolio managers since our small size allows us the dexterity to invest in companies that are simply too small for billion dollar mutual funds. Successful funds tend to outgrow the size/valuation strategy espoused by Graham as assets become larger and the investment selection becomes narrower. But this topic should best be explored at a later date.
No holdings mentioned
Brad Pappas
President of Rocky Mountain Humane Investing
Allenspark, Colorado
970-222-2592
www.greeninvestment.com
Interesting story on whats under the hood of SRI ETF’s:
Buyer Beware: What’s Really in Your Socially Responsible ETF?
Summer doldrums markets as participants are waiting for the FOMC message later today. While few expect any real change, the tone reflected in the post meeting communique tends to move markets.
NDR continues to predict that no Double Dip recession is on the horizon. Their Recession Probability Model remains at 0%. Economic activity advanced in 47 states in May and over the past three months.
Industrial Goods manufacturer Hawk Corporation (which we have a position in for clients) makes fuel cell components has raised their 2010 guidance based on an improving economy. The stock is responding nicely up $2 to $23.
Chinese Health Club owner Soko Fitness and Spa SOKF may be finally coming to life on news of two new facilities in the Harbin area. Soko is an example of a company where the valuation is hard to ignore with earnings capable of .50 cents a share in 2010 and .80 or more for 2011. While the stock has done little in light of the weakness in the Chinese stock market it has held up reasonably well. Should present growth rates continue for another year the valuation would be very compressed. Selling at just 2x book value and 7x present earnings with no long term debt, .70 in cash along with +50% revenue growth and 80% member retention rate this has some serious potential. But beware SOKF can be volatile and isn’t heavily traded with a big spread between bid and offer.
From the Carbon Disclosure Project: Corporate Clean Energy Investment Trends in Brazil, China, India and South Africa pdf
Long HWK, SOKF (client and personal accounts)
