Business - Of Mutual Fund Socially responsible investors find 'too-big-to-fail' banks too big to own

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- Should socially responsible stock investors' no-buy lists bar more than just companies peddling alcohol, tobacco, gambling, pornography, weapons, and the like? What about 'too-big-to-fail' banks?

The top-performing Appleseed Fund touts itself as socially responsible in part because it refuses to invest in traditional "sin" stocks.

There's nothing unusual about activist-oriented funds barring any stock that profits from human vice. But Appleseed (APPLX) went a step further this month. It expanded its stock blacklist to five megabanks that it says are too big for it to own: Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase and Morgan Stanley.

Appleseed's managers says the government and banks haven't tackled problems that helped trigger the 2008 financial crisis. The financial overhaul bill that cleared Congress on Thursday doesn't adequately address underlying causes that could lead to another debacle, says Adam Strauss, a co-manager of the $140 million mutual fund. Until those problems are fixed, Appleseed doesn't want anything to do with big banks.

"The cost of bailing out Wall Street since 2008 is over $3 trillion, or more than $20,000 per taxpayer, and that cost is increasing daily," says Strauss.

Appleseed's move is partly symbolic, since it doesn't require the fund to sell anything. Its small portfolio of 23 stocks doesn't include any big banks. But Appleseed's move could spark a new direction for the growing socially responsible investing movement. Appleseed is the first fund that follows socially responsible investing guidelines to explicitly screen out big banks.

The new thinking: Don't merely screen out stocks of companies profiting off vices like smoking and drinking, or those with lousy environmental or human rights records. Also boycott those whose risk-taking could jeopardize the broader economy.

"I think it's very important for investors to consider the systemic risks they create with their investments," says David Wood, director of Harvard University's Initiative for Responsible Investment.

Wood and others tracking the more than 260 funds that screen investments using social criteria say there's growing interest in expanding socially responsible investing beyond its traditional approaches. Those include screening out sin stocks, investing in companies with strong records of social responsibility, and using their ownership stakes to encourage companies to improve their corporate governance practices.

Laura Nishikawa, an analyst with the firm RiskMetrics Group, sees a shift among the foundations and other institutional investors that she advises. Increasingly, they want to know whether banks are taking risks that could endanger not only their stock prices, but the broader financial system.

A couple years ago, as the crisis was starting to unfold, many clients interested in socially responsible investing didn't think 'systemic risk' screening was appropriate.

"We felt a lot of pushback," Nishikawa said. "I think that's completely changed over the past year."

Interest in scrutinizing oil and coal-mining industry stocks is also growing, said Noel Friedman, another RiskMetrics Group analyst. The triggers are BP's failings in the Gulf of Mexico oil spill, and Massey Energy's role in the April explosion that killed 29 at a West Virginia mine operated by a subsidiary. In BP's case, RiskMetrics recently removed the company from two stock indexes of firms it regards as socially responsible.

As for banks, Appleseed's Strauss says his fund is targeting the five biggest ones because they're the biggest holders of derivatives, which are private bets between two parties over how interest rates, crop sizes or the value of a bond will change over time. Speculative derivatives trading has been blamed as a key trigger of the financial crisis.

"Warren Buffett has described derivatives as financial weapons of mass destruction, and we agree," Strauss says.

It's hard to say whether Appleseed's move will spur other funds to screen out big bank stocks. But Appleseed could prove influential if its strong performance invites imitation. Through last month, Appleseed had the top three-year record among all socially responsible U.S. stock funds. It's also been the top-performing U.S. midcap value fund over the same period, according to Morningstar.

In part, the three-and-a-half year old fund owes its results to avoiding financial stocks that tanked in 2008. Appleseed finished that year in the top 1 percent among its peers.

So far this year, the fund lags 96 percent of its peers. One reason: the bank stocks that Appleseed has been passing up have been strong performers. The KBW Bank index, which tracks the nation's 24 biggest banks, is up 18 percent this year, versus a 0.7 percent decline for the Standard & Poor's 500.

Even after that run-up, many bank stocks remain cheap, which has drawn the interest of value-oriented funds like Appleseed that specialize in scooping up out-of-favor S&P 500 stocks.

Appleseed won't be picking up any Bank of America or Citigroup shares for now. The fund may drop its boycott of big banks, if they fundamentally change, or regulators force them to.

"If 'too-big-to-fail' banks were broken up or reformed in a more structural way," Strauss says, "then we would certainly reconsider."

Published: Mon, Jul 19, 2010