Mark Brandon is the Managing Partner of First Sustainable (, 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, May 31, 2006

Domini Abandons Its Own Index Fund

Domini Social Investments, usually one of the biggest friends and beneficiaries of the SRI movement, has taken the unusual step of abandoning its own index fund, the one that tracks the Domini 400 Social Index (ticker: DSEFX) in favor of active management. The new fund has filed to hire Wellington Management as the fund manager. Since the company has been such a friend of the SRI community, I hate to do it, but I must speak my mind against this move.

The move speaks volumes about the greed pervasive in the mutual fund management business rather than the merits of either Domini, Wellington, or the Social 400 Index. You see, indexing is a low margin business for mutual fund managers. The grand-daddy of this model is Vanguard, whose flagship fund based on the S&P 500 charges a grand total of 5 basis points in expenses. That is $5 born by the shareholders for every $10,000 invested. The average actively managed mutual fund, by contrast, charges 1.57 percent, or $157 for every $10,000. What the Vanguard funds lack in high fees, they make up in volume. Their index funds are among the largest funds in the universe.

Make no mistake about it. On a macro-basis, index funds deliver superior returns relative to the actively managed set. Yes, a large number of actively managed funds deliver superior returns every year, but studies have shown again and again that the number of funds that do so consistently is frighteningly small.

The reason for the underperformance is simple -- expenses. If the market delivers historically 8 - 12 percent a year, 1.57 percent in expenses represents 13 - 20 percent of the expected return. That kind of leakage would make Las Vegas blush. In his great book "The Battle for the Soul of Capitalism", John Bogle cites a study where, over the last 25 years, mutual funds have returned on average a sum that is less than the overall market return by a number that is startlingly close to the amount that was drained in expenses. It may not sound like much, but over the working life of the average individual (43 years), that 13-20 percent leakage could mean that your portfolio at retirement is ONE THIRD what it would have been without it.

So, with it being clear that indexing delivers superior returns, the not-so-secret key to indexing well is to find the index funds with the lowest expenses. This insight has created a price war among index fund families. The management fees of the largest index funds has cratered over the last several years to where 5 basis points is now the standard.

Vanguard is the only big-name fund family that never took the "mutual" out of the mutual fund business. The company is itself owned by the fund shareholders, whereas virtually every other fund complex is owned by large financial conglomerates, so there is no pressure to pad expenses to benefit the management firms. Consequently, it is able to offer the best index funds. The Vanguard social index fund, based on the FTSE4Good index, has an expense ratio of 25 basis points, 5x higher than the S&P 500 fund, but still a good value. It does, after all, take considerable resources to add the social research and screening. The Domini fund capped their expenses at a borderline unconscionable 95 basis points for their index fund, over 3x what their Vanguard competitor charges.

The management at Domini would want to plead that this is because of the fund's size. I dispute this notion. Unlike actively managed funds, where the fund investors bear the expense of research, travel, management salaries, and customer support, the biggest expense at running an index fund should be the cost of shareowner communication -- sending the statements, prospectuses, confirmations, etc. Vanguard has more assets, but also more shareholders, and they are able to keep expenses down. The problem must be a lack of willpower to go the route of shareowner best interests. To them, it would be easier to capitalize on their name and get away with fund expenses that are many multiples of an index fund.

This is a shame. For those in non-taxable accounts, if you have the Domini fund, it is now time to switch fund families.

Wednesday, May 24, 2006

New Clean Energy Index Announced

The NASDAQ, along with Clean Tech Research firm Clean Edge, have announced a new clean energy index. The index is market cap weighted, and seeks to represent companies engaged in "manufacturing, development, distribution, or installation of emerging clean energy technologies." The technologies fall into five sub-categories, including Renewable Electricity Generation, Renewable Fuels, Energy Storage and Conversion, and Advanced Materials. This link is the official press release.

The components are listed below, with attribution to the Clean Edge web site.

Wednesday, May 17, 2006

One Modest Suggestion To Ease Gas Prices

Back in the 1970's, Congress passed a bill giving small farmers a tax break when purchasing capital equipment, then defined as light trucks weighing 6,000 pounds or more. At that time, there were no passenger cars weighing that much, so the idea that it would be exploited by everyday car buyers and soccer moms was not even considered. The term "soccer mom" did not even exist back then.

As SUV's became the most profitable niche of the car business, carmakers exploited this loophole, and started using the tax break as an incentive to businesses to buy the worst polluters and gas guzzlers, even if the business person has no use for a light truck in his or her business. A dentist can purchase a $100,000 top of the line Hummer and escape approximately $33,000 in taxes.

As everyone knows, gas prices started rising, but the incentive remains. Now, that dentist might look at purchasing a more efficient vehicle to save a few thousand a year in gas. Or, he could stick with the SUV and save tens of thousands. We're not talking about trading in the Hummer for a Prius, either. Even though a Cadillac or Lexus sedan, for example, would save our hypothetical dentist thousands of gallons per year, those vehicles are ineligible for that tax break. It's not wonder that, at least so far, SUV sales still remain strong in the face of $3 gas.

Aside from pushing the burden onto taxpayers, which should be reason enough, the tax break has distorted the market for gas prices. Assuming that eliminating the tax break would affect behavior, replacing these gas guzzlers with more efficient cars could substantially reduce the pressure on demand for gasoline, benefiting us all.

In an admittedly rose-colored, possibly naive, sense, Congress could get this done painlessly by just writing stricter requirements into the definition of "capital equipment" or "light truck". The result is not a tax increase, nor a subsidy elimination. They could also portray it as an attack on high gas prices. It would just return the subsidy to its intended use. Practically, of course, there would be howls about "American jobs" from carmakers, auto dealers, and spoiled soccer moms, and it would remain to be seen whether our elected leaders have the will to eliminate corporate welfare that has a lot of fans.

Wednesday, May 10, 2006

Telecommunications Merger Activity Benefitting Union Membership

I recently saw a Cingular Wireless ad touting the company as "the only" unionized wireless carrier in the U.S. My first reaction was that this could not possibly be true, since Verizon, T-mobile, and Sprint, all grew out of heavily unionized wireline companies. As it turns out, the assertion is more or less correct, with some qualifications. For those interested in either patronizing or investing in labor friendly companies, pay attention.

Over the last few decades, the telecom industry has gone through several cycles of divorce, spin-offs, remarriages, and consolidation. In the early part of this decade, Sprint, Verizon, and AT&T each spun off their wireless operations into separate tracking stocks. SBC and Bellsouth formed Cingular in a joint venture. A few years ago, Cingular bought AT&T wireless while the AT&T parent company was bought by SBC. Now, with the pending nuptials of Bellsouth and the newly rechristened AT&T (SBC adopted the AT&T brand, despite being the acquirer), 100 percent of Cingular will be under one roof, giving AT&T (actually, the renamed SBC) control of two baby bells, the old AT&T Wireless, and all of Cingular. Ironically, after spending hundreds of millions rebranding AT&T Wireless as Cingular a few years ago, now they are going to spend hundreds of millions more to re-rebrand back to AT&T wireless.

Confused enough? Back to the labor issues. Due to its good relationship with SBC, the Communications Workers of America are now able to organize at Cingular and Bellsouth sites. Of the 40,000 or so wireless workers in the CWA, almost all of them are now Cingular employees. Verizon has adopted a "neutrality" stance, which means that they do not stand in the way of organizing activities, but thus far, the Verizon Wireless offices have not voted to organize.

So far, AT&T (formerly SBC) contends that the unions have not stood in the way of cost-cutting measures, so for now, peace reigns between the union and management. As the "cost efficiencies" (read: layoffs) commence as a fallout of the AT&T/Bellsouth merger, we will see if that continues.

Wednesday, May 03, 2006

Bloody Tin

Thanks to a phasing-out of lead in electronic components, the global tin trade has exploded over the last few years. Cassiterite, the ore that contains the metal, is found in abundance in sub-saharan Africa. Ten percent of the world's tin originates in the Democratic Republic of Congo, where it is mined by slave labor in dangerous conditions. Children often haul sacks of the rocks for days to get to market, where once there, the price is negotiated at gunpoint.

Yet, in a recent Fortune article, executives at large electronics makers such as Samsung had no idea from where the tin originated, and they certainly were not aware that slave-labor is involved in producing it. The typical refrain was spouted: how tin is a global commodity, fungible in its nature, the source easily disguised. What can we (the companies) do about it?

Over the years, industry has responded to pressure from socially responsible investors when it comes to cleaning up the suppy chain. Nike and other apparel makers were shamed into cleaning up their acts with respect to child and sweatshop labor. Many brands of coffee are now certified as "fair trade", whereby farmers get paid a higher than market rate for their beans so that a minimum standard of living can be guaranteed. An infrastructure (albeit imperfect) has been put in place to curb the trade in "conflict diamonds." Setting up a similar infrastructure for the tin trade can also be achieved, with the help of the U.N. and other NGO's.

The data can be compiled. The Fortune article, for example, cited how neighboring Rwanda exported five times more Cassiterite than it produced while showing no imports. It does not take a slide ruler to figure that ill-gotten tin is being smuggled to its neighbors, where they are then shipped to Maylaysia and China. We have the means and the know-how, but lack the will thus far.

I am ashamed to admit that I was generally unaware of this problem, while being acutely aware of the sweat shop, fair trade, and conflict diamonds issues. Could it be that the global tin trade is less sexy than coffee, diamonds, and little children assembling soccer balls?