Mark Brandon is the Managing Partner of First Sustainable (http://www.firstsustainable.com), a registered investment advisory catering to socially responsible investors. In addition to Socially Responsible Investing (SRI), he may opine on social venturing, microfinance, community investing, clean technology commercialization, sustainability public policy, green products, and, on occasion, University of Texas Longhorn sports.

Wednesday, August 30, 2006

Are Green Consumers Gullible?

As an advocate for all things green and sustainable, I am often peeved by the firms that feel it is their God given right to charge a massive premium for sustainable products. All of us in the business have read the LOHAS and Cultural Creative Market Research. Sure, it shows that the green consumer is often willing to pay a 20 percent premium for a product to know that its creation conforms with certain social values. However, charging a Whole Foods-like premium for everyday commodities will always keep the movement relegated to the elite types who can afford it. The typical Wal-Mart shopper, who, by the way, outnumbers the LOHAS crowd by a significant margin, will rarely buy "fair trade" coffee at $9/lb when you can get Folger's for $2. And, until the everyday shopper embraces sustainable values, our impact will be minimal.

The window for making an impact with a new sustainable product or business model is getting smaller and smaller. Although this is probably so in any industry, once a market is demonstrated, the marketers among us stink it up with off-base, fraudulent, or misleading claims. Fair Trade coffee is one of those. What started out as a noble idea -- committing to give rural farmers better than market prices so that they can afford subsistence -- has now been taken over by brands that expect to charge 200% more by slapping the words "fair trade" on the label along with some bucolic scenes of Latin American peasants. Coffee is already a global commodity, and even moderately priced bags of beans carry a magnificent margin. The same can be said for organic milk now. Paying a 100 percent premium for a gallon of milk is now more than likely to by you a fancy label with pictures of dancing cows and nothing more (see a post a few weeks ago concerning Dean Foods and Horizon Organic). When there is no official definition, loose regulation, no oversight of the use of terms such as "organic", "fair trade", "all natural", "herbal", "sustainably harvested", etc., we invite abuse.

In the investment field, I have to look in the direction of the Domini family of funds, though it pains me to do so. This week, they approved a move of their KLD Social Index fund to active management. Index funds are a commodity, and the primary measure of their worth is the expense ratio. Where Vanguard charges 20 basis points for their socially screened fund, Domini tried to get away with 80 basis points. Management will tell you that this was because of their size, relative to behemoths at Vanguard, but I see that as a bunch of bunk. An index fund is on auto-pilot. Trading costs would be minimal, even at a firm of Domini's size. There are no research costs. The only thing they have to pay is for annual prospecti, statements, confirms, regulatory registrations, and presumably a license fee to KLD. So, after several years of sub-par performance , they have decided to now call their fund "actively managed", which means they will trade the markets in an attempt to beat it. By definition, an index will underperform its benchmark by the sum of its expenses, so either Domini set themselves up for failure, or they must have believed in gouging green consumers.

This move is unconscionable for shareholders. First, re-balancing a portfolio will create immense capital gains taxes, which have to be distributed to shareholders. Management says they will be "strategic" about this, which to me, means they will pretty much stay with their index and only move to active management slowly. Only now, their expense ratio is in line with other actively managed funds. Second, actively managed funds are usually a bad bet for investors for the same reason expensive index funds are bad: their expenses are too high. Frightfully few actively managed funds exceed their benchmarks over a three year period. On average, actively managed funds underperform their benchmarks by the average expense ratio, which is 1.57 percent (almost 8x the aforementioned Vanguard index fund).

If you believe in indexing, it is time to reduce or get rid of your holdings in the Domini index fund. The Vanguard-Calvert index fund is a much better choice.

3 Comments:

Anonymous Anonymous said...

Great article, Mark. I had no idea about the gouging of well-intended green consumers in the marketplace, let alone in the mutual fund world. Thanks for opening my eyes -- please keep it up.

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