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August 22, 2002
SRI Income Funds Yield Competitive Dividends
    by William Baue

Often overlooked, SRI income funds allow social investors to diversify their portfolios.

Mutual funds offer a variety of investment strategies. Most people equate mutual funds with equity (stock) funds, which often prioritize growth. Less well known are income funds, which aim to provide current income, as the name suggests. Income is paid in dividends or coupon payments from bonds or preferred stocks (preferred stocks take precedence over common stocks in paying dividends to owners). What characteristics should one look for in a good income fund?

"The answer to this is the same as what matters in choosing the right equity fund: the fund's performance over various time periods, the individual investor's risk tolerance, manager tenure, the fund's expense level, the load, and tax efficiency," said Lipper Senior Research Analyst Andrew Clark.

According to data provided by Lipper, a Reuters-owned firm that tracks 80,000 mutual funds worldwide, socially responsible investment (SRI) income fund performance compares favorably with the performance of income funds that do not apply SRI strategies. The cumulative total return of SRI income funds year-to-date (as of July 31) was 3.46 percent, compared to non-SRI income funds' cumulative return of 3.34 percent. SRI income funds' cumulative total returns were 22.79 percent over three years, 33.38 percent over five years, and 90.93 percent over ten years. Non-SRI income funds' cumulative total returns were 22.44 percent, 31.85 percent, and 88.45 percent over three, five and ten years, respectively.

Mr. Clark advises investors to evaluate their own risk tolerance first and foremost.

"If they are fairly risk averse, then investment in treasury or government funds is probably best," Mr. Clark told "If their risk tolerance is moderate, then they can start to include mortgage and investment grade corporate bond funds. If their risk tolerance is on the high side, then I would include all of the above as well as emerging market and high yield funds."

However, social investors with low risk tolerance may want to avoid income funds invested in treasury bonds.

"We have a zero-percent tolerance for war-related activity; therefore, none of our funds invest in direct obligations of the U.S. Treasury Department since these issues (bonds) are partially used to fund the Department of Defense," said Pax World High Yield Fund (ticker: PAXHX) Portfolio Manager Diane Keefe.

Instead, SRI income funds tend to invest in government sponsored enterprises (GSEs) that have a positive social impact.

"For example, we invest in Freddie Mac (FRE) and Fannie Mae (FNM) debt issues because they finance low and moderate income housing," said Parnassus Investments President Jerome Dodson. Parnassus offers a Fixed Income Fund (PRFIX) and an Equity Income Fund (PRBLX). The Equity Income Fund blends income with capital growth.

To investors with a higher risk tolerance, high yield income funds offer certain benefits over equity funds. Those benefits include a higher risk/reward ratio.

"Also, as the majority of the investment return in high yield comes in the form of interest payments, high yield funds would be ideally suited for investors with low tax rates or those in preferred accounts such as IRAs," Ms. Keefe told "Institutions generally have between two and seven percent of their portfolio in high yield, and foundations find high yield an attractive investment because they can spend the interest income on their programs."

Ms. Keefe explained that Pax World has generally had little problem identifying companies that pass its SRI screens.

"One area that has been somewhat challenging is finding environmentally strong performances in cyclical companies, but we believe that we have done a pretty good job," said Ms. Keefe. "We purchased Standard Pacific (SPF), a homebuilder that uses solar heating, and we unearthed Millennium (MCH), a chemical company that uses best practices. We also own Messer Grieshiem, an industrial gas products company that passed our environmental screens."

Employing other SRI strategies, such as shareowner action, can be equally challenging.

"In a bond fund, it is important to remember that you are holding nonvoting securities, which changes the nuances of advocacy," said Anita Green, director of Social Research and Corporate Activity for Pax World. "Since we do not have the option of initiating a shareholder resolution, we have to rely heavily on dialogue with management prior to investment. This means the initial screening is even more stringent than usual."

In addition to screening and shareowner action, SRI income funds practice community investing. For example, the Domini Social Bond Fund (DSBFX) holds more than two million dollars in certificates of deposit (CDs) with 19 community development banks and credit unions, such as the Vermont Community Development Credit Union and Wainwright Bank.

"As one example of the institutions the fund invests in, Wainwright Bank's progressive agenda includes a commitment to affordable housing, community development, women's rights and the gay and lesbian community," said Adam Kanzer, director of shareholder activism at Domini.

For social investors seeking to diversify their portfolio with long-term income fund holdings, the fluctuation of interest rates "is of no concern," according to Mr. Clark. Now is as good a time as any to buy SRI income funds.

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