Ethical Growth, Canada's oldest fund that invests in stocks using socially responsible criteria, has stumbled as the Canadian stock market has roared back to life over the past 18 months.
The $749.7-million Canadian equity fund posted a 7.7-per-cent return for the year ended July 31, compared with the 27.1-per-cent average for its peers, and 48.9 per cent for the Toronto Stock Exchange 300 index based on total returns.
The recent lagging performance has influenced the fund's longer-term record. Over the past decade, the no-load fund sold by Vancouver-based Ethical Funds Inc. has managed to chalk up a 9.9-per-cent average annual return compared with 11.7 per cent for the average Canadian equity fund, and 14 per cent for the TSE 300.
Despite the relative underperformance, fund watchers still recommend Ethical Growth to those who want a conservatively managed fund that weeds out stocks according to certain social and environmental screens. But there are better picks if investors want a general Canadian equity fund, they say.
Ethical Growth avoids companies involved with tobacco, military equipment and nuclear energy. It invests in firms with good environmental records and fair labour practices and in those that do business with firms in countries that provide racial equality and equal opportunity within their boundaries.
The fund has been managed by an outside adviser, Vancouver-based Connor Clark & Lunn Investment Management Ltd., since its inception in 1986. Ethical Growth is run by a team consisting of Martin Gerber, Alastair Dunn and Larry Lunn.
For the "ethical" screening process, they use research provided by Toronto-based consulting firm Michael Jantzi Research Associates Inc., which follows a "best-of-sector" approach in picking the best socially responsible firms by comparing their environmental and other practices with their peers.
Jill Taylor, an analyst at Merrill Lynch Canada Inc., said her firm -- which had Ethical Growth on its recommended list of general Canadian equity funds in 1998 -- dropped it by mid-1999 when the brokerage firm trimmed that list to nine funds from 11.
"It was probably one of the weaker candidates" if you were looking for performance at the time, Ms. Taylor said. But she still would recommend it for someone who specifically wanted a socially responsible fund.
Mr. Gerber attributed the underperformance of Ethical Growth mainly to the fund's conservative investment style, and not being able to own high-flying Nortel Networks Corp. for part of 1999 because of ethical concerns.
The investment approach focuses on "good businesses that are well financed and profitable and that we can buy at an attractive price," he said. But that strategy has not worked well in generally speculative markets -- including the months leading up to the 1987 stock market crash and the calendar years of 1993 and 1999.
"The hard numbers and quality of companies is not something that the market was willing to pay for," the 32-year-old manager said. Speculation in technology and other Internet-related stocks continued until the first quarter of this year, but the market has begun to move back toward fundamentals since this past spring, he noted.
Ethical Growth was also hurt because it could not hold Nortel or BCE Inc. (which had a major stake in Nortel before that was spun off this spring) for the first six months of 1999, Mr. Gerber said.
Ethical Funds grappled with whether to hold Nortel because of its 20-per-cent stake in Telrad Telecommunications & Electronic Industries Ltd., which in turn had operations in repressive Myanmar (formerly Burma).
Robert Walker, a spokesman for Ethical Funds, said his firm lifted the restriction by mid-1999 after deciding that Nortel could be eligible since it did not hold a majority stake in Telrad, and would instead voice its concerns to Nortel about its investment. That stand became a moot point when Nortel announced in March that it was selling its position in Telrad, he added.
Mr. Gerber, who had divested a small position in Nortel in late 1998, began buying Nortel shares again in July, 1999, and BCE shares in the fall. But Nortel is only about a 5-per-cent position -- well below its one-third weighting on the TSE 300 -- and that has also caused the fund to lag.
Ethical Growth also has 17 per cent of the fund in foreign stocks., which helped the fund in 1998. But Mr. Gerber said the Canadian market was "one of the best performing markets last year and so far this year."
The fund holds around 50 stocks and about 7 per cent in cash. It is underweight in the industrial products sector because of the Nortel underweighting but has an overweighting in financial and oil and gas stocks.
"Our general outlook is guarded in the near term," the manager said. "There is potential for some pullback in the marketplace. But we think the overvaluation in the marketplace is quite concentrated in the technology area, and that the rest of the market is not that expensive."
Dan Hallett, an analyst at Windsor, Ont.-based Sterling Mutuals Inc., still likes Ethical Growth as a conservative Canadian equity fund. "The screens give it a bit of a constraint but . . . they are not that prohibitive," he said. "This fund is one of the best performers when markets turn down."
Gordon Pape, author of mutual fund guidebooks, said he would also suggest Ethical Growth to investors looking for a fund using socially responsible criteria.
"This fund historically has below-average profit when markets have been strong and above-average profit when markets are weaker," Mr. Pape echoed.
"If you are looking for a conservatively managed fund that is not going to put your money at a lot of risk, and you are prepared to stay in over the long haul, it will come back."
ETHICAL GROWTH FUND
Category: Canadian equity Manager: Martin Gerber, Alastair Dunn and Larry Lunn of Connor Clark & Lunn Investment Management Ltd. of Vancouver for Ethical Funds Inc. Load status: No load Total assets: $749.7-million Management expense ratio: 2.3% GLobefund 5-star rating system:**
Returns toJuly 31, 2000
1-year simple rate of return: 7.7% 3-year compound annual: 2.2% 5-year compound annual: 11.8% 10-year compound annual: 9.9%
Top 10 holdings
1. Bank of Nova Scotia 2. Royal Bank of Canada 3. Nortel Networks Corp. 4. Magna International Inc. A 5. Suncor Energy 6. Canadian National Railway 7. Bank of Montreal 8. Telus Corp. 9. Alberta Energy Co. Ltd. 10. CIBC