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July 13, 2010
Appleseed Fund Announces Investment Policy That Excludes Too-Big-To-Fail Banks
    by Robert Kropp

Although the policy does not change an investment strategy that excludes big banks that represent a systemic risk, Appleseed is the first mutual fund to explicitly exclude them.


When a mutual fund with a success record like that of the Appleseed Fund announces a policy to avoid investment in "too-big-to-fail" banks, investors would do well to pay attention. After all, the Appleseed Fund is the top performing mid-cap value fund among 310 such funds over the three-year period that ended on June 30, and this year received a five-star rating from Morningstar, an investment research firm.

The fund was also ranked first among 194 socially responsible (SRI) domestic equity funds for the same three-year period.

Although Appleseed's announcement does little to change its investment policies—in a 2009 conversation with SocialFunds.com, Adam Strauss, portfolio manager for the fund and a partner at
Pekin Singer Strauss, the investment advisor to the fund, attributed much of the fund's outperformance at the time to "steering clear of a lot of the large-cap banks that lost a lot"—it is "the first mutual fund to create an explicit exclusion for too-big-to-fail banks in its investment selection process," according to the press release.

SocialFunds.com caught up with Strauss again following the Appleseed announcement.

"We're not excluding banks for performance reasons," Strauss said. "As a socially responsible fund, our social and environmental screens are independent of financial performance. We think the big banks represent a systemic risk, and we don't want to invest in them for that reason."

"Warren Buffett described derivatives as financial weapons of mass destruction. We saw that play out in 2008," Strauss continued. "The largest repositories of these derivatives are too-big-to-fail banks. The trader at those institutions are compensated for taking risks when they go right, knowing that when they don't go right, somebody else is going to be paying for it."

The "somebody else" to which Strauss was referring is, of course, the taxpayer, who bankrolled the
Troubled Asset Relief Program (TARP) in 2008, in the amount of some $700 billion. Public outrage over the bailout led to the financial regulatory reform bill that recently passed the House of Representatives and is awaiting expected passage in the Senate.

Strauss said of the legislation, "There are a lot of good things in the financial reform bill, but in terms of structural reforms of the industry it doesn't go nearly far enough."

"During the Depression, the Glass-Steagall Act changed the structure of the industry," he continued. "The need to restructure the industry is even greater now than it was back then. Unfortunately, the banking lobby is just too strong."

The Glass-Steagall Act, passed in 1933, prevented commercial banks from acting as investment banks as well. It was repealed by President Clinton and a Republican Congress in 1999. Although the bill currently under consideration by the Senate does contain a provision to force banks to spin off their derivatives business from Federal Deposit Insurance Corporation (FDIC) insured functions, it does not propose to split up banks whose size poses systemic risks to the economy.

According to the press release, "Until the financial system is truly restructured, the Appleseed Fund will avoid investments in too-big-to-fail banks, choosing instead to invest in regional banks, community banks, and credit unions which lend money to families and businesses that operate in the productive sectors of our economy."

Asked about the banks in which the Appleseed Fund does invest, Strauss said, "We hold the CDs of some community development banks, such as
ShoreBank Pacific, and credit unions such as Self-Help Credit Union."

The outperformance of the Appleseed Fund is especially remarkable, given its avoidance of big banks whose stock has outperformed the market recently. Asked about the investment strategies that resulted in the fund's strong performance over time, Strauss said, "We're risk-averse investors, so we tend to do better when the market goes down. If we can hold our own when the market goes up, we should meet our goal of outperforming the S&P500 over the long run."

In addition, Strauss continued, "We're value investors, so we like to buy undervalued stock. We're fairly defensive in the industries we're concentrated in, and are underweight in cyclical stocks. We look for companies with strong balance sheets and strong cash flows. At present we have a cash position of ten percent, because there are fewer undervalued stocks than there were in 2009, when our cash position was close to zero."

The healthcare sector comprises almost 30% of the fund's portfolio. "Our highest concentration is in pharmaceutical companies," Strauss said. "With health care reform behind us, there's a bit more certainty, and companies are making adjustments. In a world where an aging population is consuming more health care, pharmaceutical companies will do well."

"We look at the sustainability reports of pharmaceutical companies, and most of the companies we own have sections addressing important issues such as access to medicine," he continued. "Several of our companies are at or near the top of the
Access to Medicine Index."

"We've beaten the market year-to-date, and our long-term record remains very strong," Strauss added. "We warn our investors that there will be periods when we underperform. We want our investors to understand that we have strong opinions of what we want to invest in, so our performance is going to deviate from the S&P500. We tell our investors they have to focus on the long haul and not worry about the short term."

 

 
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