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November 07, 2006
KLD Fills Gap in Socially Responsible Investing by Launching Equity Income Index
    by Bill Baue

The KLD Dividend Achievers Social Index, created in partnership with Mergent, provides a new option for passive investment vehicles in this previously underdeveloped asset allocation in SRI.

As a still-developing field, socially responsible investing (SRI) continues to expand offerings across the asset allocation spectrum. Last week, KLD Research & Analytics added passive equity income to the SRI toolbox by partnering with Mergent to launch the KLD Dividend Achievers Social Index (DASI). While most people associate income with bonds, some equity investments in companies generate dividends and hence fall into the income category.

The index comprises 168 US companies from the KLD Large Cap Social Index (LCSI) or KLD's Domini 400 Social Index (DS400) that also satisfy Mergent's Dividend Achievers criteria of paying an increasing regular cash dividend for a minimum of ten consecutive years. The index is equal weighted to help diversify company-level risk according to Chris McKnett, KLD's Index Project Manager.

"In the course of index research and development, KLD determined that although there are a handful of equity income products available to social investors, there is not a broad-based, income-oriented index that would allow socially responsible investors to balance their portfolios against the more growth-oriented portfolios typical of SRI," Mr. McKnett told "KLD and Mergent decided to launch the DASI to fill an asset allocation void for socially responsible investors."

KLD back-testing demonstrated that the DASI outperformed the Russell 1000 over the one-, three-, and five-year periods as well as the Russell 1000 Value over the five-year period.

"But the KLD index has trailed the Russell 1000 Value over the more recent one-year and three-year periods," stated Matt Hougan on the Index Universe website. "That's a mark of back-testing integrity for KLD, as it shows that they didn't gussy up the index to create strong rear-view-mirror results."

Mr. Hougan praised the "good bloodlines" of KLD and Mergent, but critiqued the strategy as 'dividend investing lite.' He pointed out that the DASI "lags most traditional dividend indexes such as the Dow Jones Select Dividend Index, which posted 12.96 percent compound annual returns over the five-year period, beating the DASI by 1.35 percent per year.

"The purpose of the DASI is to give socially responsible investors an asset allocation tool to provide greater portfolio diversification, not to create a dividend index to outperform those already on the market," Mr. McKnett countered. "The DASI is a dividend growth strategy, not a high yield strategy."

Mr. Hougan also critiqued the sector concentration of DASI, with 43 percent of the index in financial institutions.

"Dividend indexes do not reflect the sector diversification of the market because dividend payment tends to be concentrated in certain kinds of companies," Mr. McKnett explained. "SRI indexes also typically vary from the sector weightings of the market as a consequence of the screening process."

"In general, SRI investing and dividend-based investing overweigh financials relative to the broader market indices," he added.

The true test is not whether a single commentator critiques the index, but whether investors license the index.

"Investment consultants and potential sponsor have responded very favorably to the risk/return profile of the Index, the role it can play in asset allocation plans, and the first-to-market opportunity it presents," Mr. McKnett said. "KLD and Mergent are discussing a variety of investment products based on the DASI with potential sponsors."


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