Some of our clients wish to invest in socially or ethically screened stocks. Social responsibility investment (”SRI”) mutual funds is one answer.

However, to be commercially viable, SRI funds must paint with a fairly wide brush. That is often not sharply focused enough for individual investors who have specific screening objectives, and who are comfortable owning individual stocks instead of funds.

We think a good place to begin looking for individual stocks for a personal SRI portfolio is within the portfolios of SRI funds themselves. That list is a much smaller list that the whole world of stocks, and research teams have done a lot of pre-work to narrow the field. The SRI investor can probably find what they need from there.

To make that job even easier for the do-it-yourself investor, we have compiled a merged list of 584 stocks from 6 leading SRI mutual funds:

• Neuberger Berman Socially Responsive (NBRSX)
• Ariel (ARGFX)
• Ariel Growth (CAAPX)
• Winslow Green Growth (WGGFX)
• Domini Social Equity (DSEFX)
• Vanguard FTSE Social Index (VFTSX)

You can download that list of 584 SRI screened stocks here. It’s a straight list with no evaluation of the merits of the stocks, but it will save you a lot of time. An image of the PDF file pages looks like this:

We selected the 6 SRI mutual funds from 22 SRI funds covered in a US SRI funds study we published in March 2007.

That document is also available for download here.

The “Summary” for that report said.

“We identified 22 social responsibility investment funds with approximately $100 million or more in assets and at least 5-years of operations. Of those, 16 outperformed the S&P 500 proxy SPY over five years, indicating that values-based investing does not necessarily compromise potential returns. We also found that 6 of the 22 funds performed in the top ½ of the group for each of 3, 5, and 10 years, or 1, 3 and 5 years. Of those, one fund stands out as the best overall investment choice with good returns, a moderate expense ratio, and a small enough asset size that it can effectively take positions in smaller companies that larger funds cannot. That fund is Neuberger Berman Socially Responsive Fund (NBSRX).”

If you manage your own socially screened portfolio, this information should be helpful to you. If you want an individualized SRI portfolio, but need help putting it together or want one designed and managed for you, we stand ready to help.

Richard Shaw
QVM Group LLC

The Investment Company Institute reported $26 trillion worldwide mutual fund assets from 26 reporting countries for the year 2007.

They reported assets for 2002 - 2007 which shows a 5-year average increase in total assets of 18.3% (net new money + performance), and a 2007 asset increase of 23%.

It is interesting to see how investors worldwide in the aggregate have committed their money, and which parts of the world have placed the most money into mutual funds.

There are about 66,000 mutual funds in total. That is probably substantially more funds than there are investable stocks.

The Americas (including all of North and South America) hold just over 1/2 of worldwide mutual fund assets. The Africa/Asia component will likely increase as a percentage as their populations become more affluent.

The allocation of assets by fund type differ significantly between US investors and non-US investors. US investors make a somewhat larger allocation to equities than the rest of the world.

It is interesting to observe that the effective asset allocation of US investors is 57% stock and 43% bonds and money markets (estimating a 50/50 mix of stocks and bonds in the “Balanced/Mixed” funds category). That is quite similar to the classical 60/40 stock bond allocation, such as available through the Vanguard Balanced Fund (VBINX, expense ratio 0.19% for small accounts and 0.10% for amounts over $100,000).

When you consider how US investors have experienced the “friction” that Warren Buffet has defined, US investors have given up a lot to get somewhere they could have gotten more cost effectively. That friction costs investors $12 billion for each 1/10th of 1% in asset management expenses, and does not include fund sales loads, trade execution costs or income taxes due to active trading.

On the other hand, a fund such as VBINX has no sales loads, bare bones management fees, and a tax efficient passive index approach.

Overall, US investors have given more to fund management companies, Wall Street brokerages, fund sales agents and the Internal Revenue Service than they needed to do.

That same balanced approach is also easily achievable through ETFs by combining a broad US stock market ETF and an aggregate bond market ETF — with favorable entry costs (perhaps $10 - $25), favorable costs of staying in (perhaps 0.09% to 0.20% annual expenses), and low tax drag due to use of passive index funds that have minimal trading except for rebalancing.

Examples of broad US stock market ETFs available from the three largest ETF sponsors are:

• VTI (0.07% expense, from Vanguard)
• IWV (0.20% expense, from Barclays)
• IYY (0.20% expense, from Barclays)
• TMW (0.20% expense, from State Street)

Examples of aggregate US bond market ETFs from the same sponsors are:

• BND (0.11% expense, from Vanguard)
• LAG (0.13% expense, from State Street)
• AGG (0.20% expense, from Barclays)

We are not suggesting that a balanced fund approach is right for everybody, or that skill cannot out perform the market — but we are saying that in the aggregate US investors left a lot of money on the table for managers and distributors by effectively creating a $12 trillion balanced mutual fund simulation.

Lesson — if you buy funds of any type (mutual funds, ETFs or other), make sure that you are not working hard and expensively to recreate an overall broad index. Either tilt away from overall market composition with reason and conviction, or buy an overall market index with one or two funds.

In any case, seek a low cost of entry, a low cost of staying in, and a low cost of exit, with no more tax penalty than is essential to accomplish your exposure objectives and risk management.

Richard Shaw
QVM Group LLC

The news is constantly full of “investment themes” — BRIC, commodities, falling Dollar, alternative energy, mortgage crisis, and so on.

Investing with themes is a good idea, because you will be swimming with the stream instead of against it. However, themes don’t last forever.

Getting onto a theme too early can be costly in terms of losses or “dead money”. Getting in too late can result in underwhelming profits or even losses, if everybody else is exiting when you are entering.

Whatever theme you may be contemplating, we think it is useful to analyze it in terms of generic theme dimensions. From our perspective, those dimensions are:

• Development Time
• Strength
• Duration.

Properly classifying themes will help you decide if they are right for you. For example, a fast development, weak and short duration theme is suitable only for the nimble — essentially short-term traders. On the other hand a slow development, strong and long duration theme is not really suitable for a trader, but may be suitable for a long-term investor in an asset allocation program. There are many degrees between those two extremes.

To help you with classification, we have developed this three-dimensional chart that creates 27 theme categories:

Richard Shaw
QVM Group LLC

The wages of work have not been so great for most Americans in the last few years — barely keeping up with published inflation, which we all know is far below real inflation when energy and food are included.

The wages of ownership, however, have been much better. Over the past 45 years or so, dividends paid to investors by the S&P 500 index have risen by an average of about 6%.

Except for unusual 11+% dividend growth in the last 5 years, dividends have grown on average between 5.5% and 6.5% per year; depending on how many years you look back.

That’s good news for retirees with dividend oriented stock portfolios. Retirees face inflationary cost spirals just like everybody else, but all too often find themselves on fixed incomes from pensions or bond holdings or annuities that they purchased so they would not “outlive their assets”. The problem with fixed incomes is that inflation ravages them.

We think retirees need to include equity income (dividends) in their retirement portfolio mix. Each person’s situation is different, but dividend income should at least be considered for part of a retirement asset allocation.

While the price level of the S&P 500 index has been volatile, the actual number of Dollars paid by the index has not been volatile. It has risen rather smoothly over the years.

Dividends did decline slightly in 5 of the past 47 years, averaging -1.7% per decline, as follows:

• -1.54% in 1970
• -0.94% in 1971
• -0.12% in 1986
• -2.63% in 2000
• -3.26% in 2001

Those are miniscule in comparison to the declines seen in earnings or the index price level.

The index earnings declined in 11 of the 47 years, and averaged -9.1% for those declines, the greatest of which was a -14.9% decline.

The index price level declined in 12 of those 47 years, and averaged -13.3% for those declines, the greatest of which was -29.7%.

When you think about predictability of earnings, dividends and index price levels, it may be useful to take note of who controls the outcomes. Investors control the price level of the index. Management and company directors control dividends. Earnings are controlled by a combination of management, general economic conditions and customer decisions about the products or services provided by the companies in the index.

Clearly, investors are a more skittish and fickle group, making index price levels the most volatile. Management and directors are conservative in letting go of cash flow to pay dividends, and in creating precedents and expectations that they will be expected to repeat or beat in future years – that makes dividends non-volatile and most predictable. Earnings are controlled by multiple forces, only one of which is management, putting earnings between index price levels and dividends in predictability and volatility.

Most retirees with fixed amounts of capital need to think about predictability and volatility in their investments more than younger people. That’s why they tend to focus on bonds or fixed payout annuities — and why they tend to nervous about stocks.

However, if retirees looked at large-cap stock indexes instead of individual stocks, and at the dividend income more than the price level, they might give stocks more consideration.

Dividends are reasonably predictable, and unlike bond interest, they have a tendency to grow and overcome the ravages of inflation.

For example, if a retiree was earning $100,000 in dividends from a stock portfolio, and that was sufficient to cover the full cost of living for that retiree, how important would it actually be if the stock portfolio paying those dividends declined by 20% one year? Not really very much. If the retiree believes the dividends are secure, the price level of the portfolio isn’t a primary concern.

Virtually all of the media reporting, and the majority of the fund reporting is about price levels with comparatively little about dividend income levels.

We think people with income orientation are looking through the wrong end of the telescope if they focus on stock price levels. They should be looking first at their portfolio dividend income, and the dividend payout ratio from earnings – putting price level last, not first. If the payout ratio is reasonable and the dividend yield is attractive, then the price of the stocks can gyrate without harming the retiree.

If a retiree can live entirely on dividend income and not invade capital, then price level drawdowns aren’t as important in the question of outliving your assets as the dividend growth level versus inflation.

Of course, for retirees, who must utilize both income and capital to survive, price level is important, because multi-year price declines combined with fixed dollar consumption of capital can deplete a portfolio. Those investors are at higher risk of outliving their assets.

The S&P 500 index through proxy funds such as SPY and IVV pays a current dividend yield of about 2.1% ($21,000 in annual dividends per $1 million invested).

Of the 500 stocks in the S&P 500, fully 384 pay dividends (averaging 2.59% yield) and only 114 do not pay dividends. That provides strong protection against the inevitable stinker that pops up unexpectedly in most portfolios, such as Bear Stearns or Washington Mutual as recent examples. Diversification is key to reducing stock selection risk and to improving predictability of results.

The highest yielding portions of the S&P 500 index are financials (proxy XLF, 3.70%) with banks in particular paying high yields lately (proxy KBE, 6.44%), plus telecommunications (proxy VOX, 3.22%) and utilities (proxy XLU, 3.04%).

One way to increase portfolio dividend yield is to add some higher yielding sector funds to a core S&P 500 or other broad index portfolio. Alternatively, there are the high dividend stock funds (proxies DVY, 4.29%; SDY, 4.00%, as examples).

Be aware that any high dividend stock fund will tend to be biased toward the high yield sectors: banks, telecom, and utilities; but they can capture members of other sectors which pure sector funds will not do.

If you are retiree which ample capital, give some thought to a dividend oriented stock allocation in your portfolio along with your consideration of bonds and annuities.

Richard Shaw
QVM Group LLC

We believe that executives at Washington Mutual don’t do right by their shareholders.

They made bad business decisions by loading up on subprime loans.

When the losses flooded in and the stock plummeted about 75%, they changed the terms of the deferred compensation plan to allow employees (read most of the money was for executives) to take a one-time cash out of the money before 12/31/2007 (note that deferred comp is subject to general creditors of a company). [see our Nov. 25, 2007 article on that -- stock price $18.21]

Then they modified executive bonus plans to reduce consideration of losses due to the bad loans from the ill-conceived subprime strategy that caused the stock to plummet [see our Mar. 5, 2008 article on that -- stock price $12.80]

Then they cut the dividend to shareholders from $0.56 to $0.15. Again no direct pain for executive compensation.

Now they have sold $2 billion of new issue shares to an investor group at $8.75 per share when the market closed the prior day at $13.15; and sold $5 billion of convertible debt that surely has a conversion price that will create a strong resistance price level until the bonds are all converted. And they virtually eliminated the dividend, dropping it to $0.01 per share.

So — capital losses for regular shareholders and a virtual total loss of dividend income from regular shareholders, but no rights offering of shares and convertible bonds to regular shareholders to recapitalize the company at the huge discount offered to an investor group.

Yes, the new investors are shareholders now too. They are taking big chances; but what about the pre-existing shareholders? Shouldn’t they have been given the same opportunity in a rights offering? That would have taken some time, but they have had the last several months to ponder their capital needs.

Yes, this cash infusion is important to survive the company, and we expect the new shareholders will exert strong influence and cause more economically rational management decisions.

However, was it really necessary to leave the ordinary shareholder so completely in the cold? Was it “fair” to enrich executives to implement terribly flawed lending plans, and then protect their deferred comp and bonuses after the crisis nearly killed the company? Was it “fair” to recapitalize the company without any offer to existing shareholders to participate? Was if “fair” to eliminate the dividend for pre-existing shareholders, while issuing interest paying convertible debt to the new investors who have the equity upside too?

What a horrible situation. What an unfortunate example of how companies shouldn’t treat their shareholders.

The shares are trading at about $11.60 to $11.85 right now a few hours after the announcement. Will the new capital cause shareholders to see new value and stabilize or increase the price — or will shareholders react to being $3.00 above the new issue shares and being capped by the conversion price of the bond by trading down?

Institutions are probably mostly out if they plan to be out. Speculators are probably a bigger portion of the shareholder base than normal. The news will be digested by a wider audience tonight and tomorrow will probably tell much of the story — thumbs up or thumbs down. It is not at all clear which way this move will push the chart.

New capital for a bank is good news for the market. A deal like this may be frustrating to investors who may see a major flat spot in the price future, or they may see a bright new future from a low point.

We’re short WM. Time will tell. It could go either way.

The 10-day, hourly chart below tells some of the story.

The stock was anticipating something yesterday, but was somewhat disappointed today — not to the extent that it was unhappy the day before yesterday.

This is the news as reported today by Bloomberg:

“April 8 (Bloomberg) — Washington Mutual Inc., the largest U.S. savings and loan, got $7 billion from a group of investors led by David Bonderman’s TPG Inc. after losses on subprime loans ate up capital and erased 74 percent of its market value.

Washington Mutual sold 176 million shares at $8.75 a piece, 33 percent below yesterday’s closing price on the New York Stock Exchange, and $5.5 billion in convertible preferred shares, the company said in a statement today. TPG will buy $2 billion of the shares. The lender also slashed its dividend and announced 3,000 job cuts. The stock fell as much as 13 percent.

Chief Executive Officer Kerry Killinger, struggling to reassure investors the bank has enough capital to stay afloat, said the dividend cut will preserve $490 million annually.

“When a firm has to double its shares outstanding and yet still be under credit-quality pressure, it’s not a particularly comforting move,” said Sean Egan, managing director of Egan- Jones Rating Co. in Haverford, Pennsylvania.

Washington Mutual will stop making loans through mortgage brokers and close its home loan offices, while focusing on its 2,500 bank and small business lending offices. The unit that’s being closed, known in the trade as wholesale mortgage lending, contributed 40 percent of fourth-quarter originations, according to a slide presentation. …

The quarterly dividend was cut to 1 cent a share from 15 cents, the second time it’s been reduced since November 2007 when it was 56 cents.

The infusion, originally planned for $5 billion, was increased because of strong investor demand, according to Washington Mutual spokesman Derek Aney. …

“It’s dilutive for shareholders on a massive basis, so it’s not great for the company, but it’s great for the system that capital can be raised during these stressful times,” Vincent Farrell, a principal at New York-based Scotsman Capital Management LLC, said on Bloomberg Radio.”

Richard Shaw
QVM Group LLC