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May 05, 2006
Student-Managed Socially Responsible Investing Fund Outperforms the Market
    by Bill Baue

The faculty advisor to the Arnone-Lerer SRI Fund at Villanova University attributes a quarter of the outperformance to environmental, social, and governance factors.

While university professors argue in the academic literature over whether socially responsible investing (SRI) outperforms or underperforms, a group of Villanova students has stepped outside the ivory tower to test SRI with real money in a student-managed fund. Their findings? SRI outperforms.

"As of the end of April, we're up 28.82 percent in total returns since the March 2004 inception, and the S&P 500 total return is up 24.70 percent," said David Nawrocki, a professor in Villanova's College of Commerce and Finance who oversees the Arnone-Lerer SRI Fund.

During the same period, the portfolio slightly outperformed the Russell 3000 (28.04 percent total returns), the Russell 1000 more soundly (26.91 percent), and the Domini 400 Social Index significantly (15.53 percent).

"We think as much as 100 basis points per year of the outperformance is attributable to the social, environmental, and governance screens we use, and the remainder of the outperformance is going to come from our sector rotation," Prof. Nawrocki told "We're top-down, which means we start with the business cycle--where we are in the business cycle determines which industries we look at, usually about 15 of 120 industries at any point in time."

"Once we have the industries determined, that's when the securities analysis comes in," said Prof. Nawrocki. "The first step is social responsibility screening--no stock moves forward into the securities analysis unless it passes the screening of IW Financial."

Taking its cue from Villanova's Augustinian code of ethics and the US Catholic Bishops' Statement on SRI, the fund applies exclusionary screens on tobacco, abortion, and pornography. The fund also uses IW Financial ratings tool to apply positive screens at different levels according to student prioritization, with slight variation from year to year as classes matriculate. Now, human rights and weapons get high priority; environment, labor relations, workplace, and board diversity medium; and animal testing, sexual orientation, nuclear power, alcohol, and gambling low.

"One year I was able to get board diversity up to a 'high' because I argued for it, but I let them make the decisions," said Prof. Nawrocki.

"To screen or not screen alcohol issue drew the most heated debate!" said Graham Sinclair, a Villanove MBA graduate who worked on the fund during its genesis. Mr. Sinclair is now research product manager at KLD Research & Analytics. "The initiative began in fall 2003, pulling students strong in investment analysis and SRI issues--including members of the winning undergraduate ethics debating team."

Acting Dean of the College of Commerce and Finance and his wife Steve and Maria Arnone Stumpf donated stocks worth about $100,000 to seed the fund. Returns get reinvested until assets double, at which point excess returns go to support the university's Center for Responsible Leadership and Governance, which Prof. Stumpf helped found (fund assets are part of the university's endowment). The Stumpfs stipulated the SRI orientation to reflect their concern for the long-term sustainability of the global economy, and named the fund in honor of two teachers that mentored both of them--Lawrence Lerer and Eugene Arnone, Maria's father.

Prof. Nawrocki's experience has played a key role in the fund, which uses the business cycle strategy he developed for use with the investment advisory firm he co-founded, QInsight Group, which manages about $30 million. Earlier in his career, he worked for Morgan Guaranty Trust, an insurer that offers directors' and officers' (D&O) insurance. The firm recently sponsored his students as interns who used KLD research to investigate factors causing shareholder lawsuits the firm had to pay out to cover D&O policies.

"We found there were a number of SRI and corporate governance factors that were predictors for shareholder lawsuits, and those have become part of the rate-setting for D&O insurance," said Prof. Nawrocki. He subsequently used these factors in screening companies for the Arnone-Lerer fund. "Those were really our best predictors."

"At QInsight, we see 'disasters du jour" where stock prices quickly drop some 30 percent--a lot of those are tied to poor corporate governance and social responsibility," he continued. "In the two years we've been operating the Arnone-Lerer fund, we've only had one disaster du jour, and it was right off the bat--one of the first stocks we bought."

Prof. Nawrocki also looks to insurers to see the horizon of developing issues that can impact investment performance. For example, he points to re insurer Swiss Re, which has started to look at climate change and companies' exposure to carbon risks in its policy-writing. He also looks at the market, and sees companies like DuPont (ticker: DD) and General Electric (GE) implementing programs for minimizing carbon emissions over and above their legal obligations.

"Carbon exposure climate change are issues we're seeing coming down the pike," he said. "I don't care what political view you hold--when insurers and the market are saying there's global warming, that represents a pretty big consensus within society."

The response from the academic community on the funds' results has been lukewarm.

"We're too small--the portfolio is only $126,000 with 25 to 35 stocks (compared to 50 or 60 for most institutional investors' portfolios), and having less than a three year track record is also a limitation to making any claims about this approach," he explained.

However, student response has been much warmer.

"By learning the real issues of managing money not just for profits, but for higher standards of environment, society, and governance, the SRI fund experience gave the Villanova cohort better investment profession potential," Mr. Sinclair told "And for the skeptics in the class, the Arnone-Lerer's positive performance has been a real eye-opener--even the university treasurer was pleasantly surprised at the returns."


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