Amy Domini, the chairman and president of Domini Funds of New York and a widely respected pioneer of the socially responsible investment world, recently announced that four of her eight mutual funds would no longer invest according to the socially responsible equity index that bears Domini's name. Instead, in a provocative move intended to pump up the sagging performance of the funds, the funds will shift to an active investment management strategy later this year.
This surprising change in strategy was quietly revealed in a preliminary proxy statement the fund group filed with the SEC last month. If plans are approved by Domini fund shareholders, effective this November, Wellington Capital Management of Boston will begin managing the funds, supplanting State Street Global Advisors of Boston as the funds' sub-advisor.
Wellington, with $550 billion in assets under management, has been the sub-advisor to the actively managed Domini European Social Equity Fund since its launch last October. A Wellington official declined comment.
But while the funds will no longer seek to replicate the Domini 400 Social Index, which Domini first created in 1990, Domini will be exclusively calling the shots as to the social screens, both positive and negative, that will apply to these funds. Right now, the social, environmental and corporate governance screens are being handled by KLD Research & Analytics of Boston. KLD Research (the "D" stands for Domini) actually owns the social index that Domini licenses and employs. But Domini will be bringing that screening process in house when the changeover occurs.
The four funds are feeder portfolios off one master equity index portfolio. They include the flagship $1.2 billion no-load Domini Social Equity Fund, which was incepted exactly 15 years ago this month; the $36 million Domini Social Equity Fund Class R for retirement plans, which debuted in November 2003; the $261 million Domini Institutional Social Equity Fund, which premiered in May 1996, nearly five years after the flagship fund; and the most recent addition to the family, the Domini Social Equity Portfolio Class A, which was created as a clone for the broker/dealer marketplace and debuted 11 months ago (see MME 11/08/04). That fledgling fund currently sports a mere $459,000 in assets.
Fees to Increase
According to the proxy, investors will also be in for a management fee increase once the now passive index funds change over to their active management strategy. That active strategy carries a higher price tag and will increase the annual management fee paid to the fund advisor, Domini Social Investments, by as much as 50%, although breakpoints will reduce management fees at higher asset levels. Domini officials also point out that although the management fee will rise, the fund's total expense ratio will be contractually capped on a year-by-year basis going forward.
Why the change? A review of the Domini Social Equity Fund's short- and long-term performance reveals that the socially responsible fund's performance has repeatedly lagged the performance of the broader proxy for the U.S. equity market, the S&P 500.
From inception of the fund through March 31, the fund returned 9.89% versus the 10.61% return of the S&P 500 over the same period. Over shorter time frames, the performance gap widens. Three-year returns through March 31 differ by a sizable 2.29 percentage points, while one-year returns differ by a notable one percentage point, with the S&P 500 trouncing the fund both times.
The decision to shelve the Domini 400 Social Index, which Domini helped create and consists of 400 primarily large-cap domestic companies selected under a range of social criteria, for four of its funds was by no means an easy decision for Domini executives, conceded Adam Kanzer, general counsel and director of shareholder advocacy at the firm. The change was absolutely driven by performance considerations.
"It was a very difficult decision," Kanzer said. "Recent performance has been [equally] disappointing. There is only so long you can ask your shareholders to hang in with you."
Index Not Forsaken
Despite changing the investment strategy for the funds, Kanzer made it clear that Domini is not abandoning the Domini 400 Social Index. "This is not us walking away from the index," he affirmed. "The index is valid and we absolutely support the index."
But the index isn't perfect. It is market cap-weighted, meaning that the largest component companies have driven the good or poor performance of the index and results are often affected by market sector biases, Kanzer explained. That market cap-weighted aspect is fixed and cannot be adjusted.
Moreover, while some of the companies with smaller market caps have done very well, their performance hasn't had a big impact on the index or Domini's index funds because they aren't as large a component of the index, he added.
"The strategy we're proposing is in the best interest of our shareholders. We have an obligation to our shareholders, and we are moving to a strategy that we feel is more compatible to our screens and is pretty reasonably priced," Kanzer said.
While expectations are high, Domini may still face an uphill battle. According to Srikant Dash, index strategist with Standard & Poor's in New York, "across most categories, indexes have outperformed funds with active management." For example, over the most recent three-year period, 61.9% of actively managed large-cap funds underperformed the S&P 500 index itself. That number balloons to 67.1% over the past five years. Over the long-term, "a passive strategy will outperform the active fund," Dash suggested.
Finding a New Niche?
Domini is in perhaps a unique situation as it, at some level, must compete with the likes of other index fund providers, some with rock-bottom expense rations such as Vanguard of Valley Forge, Pa., while at the same time competing with other socially responsible mutual funds including those from Ariel, Calvert, GuideStone, Parnassus and Neuberger Berman. These socially screened fund providers have broader distribution and, according to Morningstar, have significant dollars from like-minded socially responsible investors in their coffers (see chart, page 10).
At the end of the day, a passive versus active strategy is secondary to Domini's reputation as a socially responsible manager. "The Domini Social Equity Fund has first and foremost been a socially responsible fund," Kanzer summed up.
"We believe in active management," said Jack Robinson, president and chief investment officer of Winslow Management Co. in Boston. Winslow is advisor to the $300 million environmentally screened Winslow Green Growth Fund and newly hired manager of North American equities for Jupiter Green Investment Trust, a closed-end socially responsible fund managed by London-based Jupiter Asset Management. "The only way to beat an index is on the active management side," he added, noting his respect and support for Domini's decision and her pioneering socially responsible index.
The actively managed Winslow small-cap growth fund's performance is officially benchmarked to the Russell 2000 index. But internally, portfolio managers benchmark against the Winslow 100, an equally weighted equity index that the firm created five or six years ago, Robinson said.
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