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The New SRI

Negative ESG screening is old hat. Green Alpha Advisors starts with a sustainability model, then finds companies that fit it.

Socially responsible investing started out as a way for many religious investors to avoid companies that profited from products and services that went against their beliefs. While many faith-based funds still take that approach, that also gave way to SRI funds that screen out companies that don’t meet environmental, social and governance (ESG) criteria.

But the newest wave of SRI, as exemplified by Green Alpha Advisors, looks for companies that do meet certain ESG goals.

“We felt it was more interesting to drive sustainability to the front of the stock selection process,” says Green Alpha co-founder and chief investment officer Garvin Jabusch. “It’s important to have an economy that can thrive, addressing climate change, water problems and degrading farmland. We have a model of a sustainable economy and then find companies that fit it.”

At least one academic study shows that positive-filter ESG funds outperform negative-filter funds, says Jon Hale, director of sustainability research at Morningstar.

Green Alpha, based in Boulder, Colo., has five funds, including one available through brokerages—Shelton Green Alpha Fund (ticker: NEXTX). Jabusch and his colleagues see their portfolios reflecting the “next economy,” which they define as one that’s “ecologically efficient, helps mitigate climate change, promotes both energy security and national security and helps produce high-quality, enduring job growth.”

Green Alpha constructs its portfolios to reflect all parts of the economy, not just energy, Jabusch says. The firm takes a sustainable approach to each industry and then selects companies matching that approach.

“There is no such thing as a perfect company” on sustainability, Jabusch says. So Green Alpha managers choose companies that have more than 50 percent of their revenue devoted to sustainable activity. Toyota doesn’t make the cut, despite its Prius hybrid model, and ABB Group does, despite a large carbon footprint.

Of course Green Alpha isn’t just looking for companies that do good; it also wants companies with strong financial performance. “It’s companies with strong earnings per share (EPS) and revenue growth with a minimal amount of debt, at the same time that they are solving for the earth’s biggest risks,” Jabusch says. “That’s a recipe for long-term performance.”

Green Alpha opts for companies with a price-to-book ratio close to 2, compared to a ratio of about 3 for the S&P 500. Meanwhile the Shelton Green Alpha Fund has an EPS growth estimate of 12 percent for the next year, compared to negative EPS growth forecast for the S&P 500, Jabusch says. “You’re paying less but for more growth.” So he sees no conflict between investing for sustainability and investing for strong returns.

Among Jabusch’s favorite companies are solar panel manufacturer First Solar, food maker WhiteWave Foods and Hannon Armstrong, which provides financing to the energy industry. First Solar has a superior panel and is growing its market share, revenue, profits and profit margin, he says. WhiteWave, which produces organic milk, has double-digit revenue growth. And Hannon Armstrong, which is a real estate investment trust, offers a hefty yield of 5.1 percent.

Green Alpha isn’t the only shop doing this. “The field of sustainable investment is growing very rapidly,” says Morningstar’s Hale. “It’s poised to become a mainstream way of investing. Almost all asset managers are trying to incorporate ESG into their investment procedures in some way.”

This move makes sense, he says. “A growing body of research suggest that companies with a strong sustainability performance on environmental and social challenges and the best practices in corporate governance tend to be the best performers.”

Socially responsible investment equity funds generated average annual returns of 1.59 percent for one year, 6.46 percent for three years, 11.19 percent for five years and 6.29 percent for 10 years ending Aug. 9, according to Morningstar data. The corresponding numbers for non-SRI actively managed equity funds were 1.76 percent, 6.08 percent, 10.55 percent and 6.15 percent.

So SRI funds outperformed in every period but one year. These numbers encompass funds with both foreign and U.S. stocks (including Green Alpha). Narrowing the category to just U.S. stock funds, SRI funds outperform in every period, though only by one basis point over the 10-year period.

The Shelton Green Alpha Fund, which began March 12, 2013, scored an annualized return of 1.58 percent for the year ending Aug. 15 and 7.28 percent for the three-year period. That compares to -1.4 percent and 8.16 percent, respectively, for Morningstar’s mid-cap growth category, where it places the fund. “That’s OK for three years, but not that outstanding,” Hale says.

But Jabusch says a fairer comparison for the fund is an all-cap stock index, because the fund holds stocks of all capitalizations. His preferred index is the MSCI ACWI (all-country world index) Investable Market Index (IMI), which returned 0.69 percent for the year ended Aug. 15 and 4.35 percent annualized for the three-year period. So Shelton Green Alpha outperformed the index handily in both periods.

Hale says Morningstar bases its capitalization designation on the average capitalization of a fund’s holdings, and that’s how the Green Alpha Fund ended up in the mid-cap category. The fund’s biggest holdings in terms of percentage of assets are Pattern Energy Group, Vestas Wind Systems, Canadian Solar, First Solar, Applied Materials and IBM, in descending order.

While it’s a difficult to judge a fund after three years, Jabusch expressed confidence that Green Alpha funds will perform well over time, as long as he and his colleagues maintain their discipline in opting for companies based on their sustainability and financial performance.

“All funds have to sink or swim on the merit of their performance,” Hale says. “Strong performance after fees will be necessary to get people in.”

Dan Weil is a freelance financial writer. His work has appeared in The New York Times, The Wall Street Journal, Bloomberg, Institutional, Slate magazine, and Tennis magazine. He has also worked as a reporter at Bloomberg, Reuters and Dow Jones.

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