Although socially responsible investing has been slow to catch on with Canadian investors, it’s hard to argue with those who take a stand against tobacco, alcohol, pornography or a host of other “sins.”

In theory, SRI screens out attributes that can be associated with poor corporate management, poor environmental practices or shabby labour relations. In recent years, this preference has cost SRI investors a fair amount of money. With very few exceptions, SRI funds have lagged their less focused peers. But some believe this can change.

One long-standing Canadian equity fund using an SRI approach is the $33.7-million Summa C Fund offered by Winnipeg-based Investors Group Inc. (Including serval classes of units, the fund has $2-billion in total assets.) The fund dropped 23.9% in 2002, when just about every other fund was down just half as much. It subsequently jumped sharply, delivering a reasonable gain of 23.1% in 2003, vs a rise of 26.7% for the S&P/TSX composite index. In 2004, the fund was up only 9.3%, vs a 14.5% return for the index. Year-to-date as of Nov. 30, 2005, the fund was up 11.1%, again falling behind the benchmark.

A smaller, socially screened offering is the $416-million Ethical Growth Fund offered by Vancouver-based Ethical Funds Inc. , the dominant brand in the group. Lagging the index sharply each year, the fund lost 15.1% in 2002, then climbed 17.5% in 2003, before rising 13% in 2004. It was up 11.6% year-to-date as of Nov. 30, 2005, also well behind the benchmark.

Not surprising, each of the struggling funds earns a disappointing two-star rating from Morningstar Canada.

Summa Fund is co-managed by Keith McLean, who before IG worked for both McLean Budden Ltd. and the New Brunswick government, and Daniel McClure, previously with Sceptre Investment Counsel Ltd. and Morgan Stanley.

In addition to maintaining a diversified portfolio, the growth-oriented Summa managers, who took over the fund three years ago, seek companies with steady earnings growth, a high return on invested capital, a well-trimmed balance sheet and good corporate governance. The fund doesn’t invest in companies whose businesses involve alcohol, tobacco or weapons. It also avoids companies with poor environmental records and those unfriendly to unions.

At Ethical Growth, the shaky results led to a shakeup of the senior management and the replacement 18 months ago of long-time managers Connor Clark and Lunn Investment Management Ltd. of Vancouver with Guardian Capital Inc. of Toronto.

Ethical Growth is now under the stewardship of Robert Hammill, managing director of Canadian equities at Guardian, who joined the firm in 1988. He is a member of Guardian’s strategic investment committee and has more than 20 years of investment experience. Co-manager Ted Macklin’s industry experience includes stops at Confederation Life, Elliott & Page Ltd. and Bolton Tremblay Inc.

Ethical Growth screens domestic stocks according to its criteria of social responsibility, including prohibitions against tobacco, weapons and nuclear industries. Guardian’s managers then plumb this mostly large-cap universe for both valuation and growth characteristics, looking for companies that offer good growth prospects and trade at reasonable valuations.

Recently, neither fund held much cash, nor do they have substantial holdings in income trusts. Hammill hopes a resurgence in non-Canadian equities will help the Ethical fund catch up to its peers. Consequently, in tandem with foreign subadvisors Harding Loevner and Atlanta Capital Management Co., he has increased the U.S. and overseas component significantly in the past year.

McLean also tries to keep a significant portion of the Summa portfolio outside the country. Right now, that means a 24% allocation, virtually all of it in the U.S.

In Hammill’s case, the Ethical fund’s top 10 holdings account for 30% of assets, while in McLean’s, they represent closer to 40% of the fund. The Ethical fund often holds more than 130 positions, one-quarter of them outside the country, whereas the Investors Group fund tracks roughly half as many. Both funds are low-turnover options.

Both funds favour larger-cap stocks that produce similar dividend yields. Each also employs a “growth at a reasonable price” investment style, Morningstar reports, the measures of which are largely in line with the S&P/TSX index. The two funds also have many large holdings in common; EnCana Corp., for instance, is the largest company in both funds.

At time of writing, the Ethical fund was modestly underweighted in the energy sector, with a tilt toward technology and financial services.

@page_break@The Summa fund holds roughly the same weighting in financials as the Ethical fund and is likewise overweighted in infotech, with a smaller tilt toward energy and an above-market weighting in utilities. Major holdings include most major banks, as well as Manulife Financial Corp.

Given their common roots and limited portfolio choices, you might expect the two funds to exhibit similar risk profiles, but there is a significant difference. Ethical Growth posted a five-year standard deviation of 11.8, less than the 13.9 posted by the index, while Summa registered an even higher 14.6.

Risk-adjusted, the Ethical fund has a break-even five-year Sharpe ratio of 0.03, essentially matching Summa’s negative 0.07 and suggesting that both managers’ stock-picking has been spotty over the longer term. On a three-year basis, however, the two funds’ somewhat improved fortunes have them running neck and neck.

Investing with a conscience has its cost, and Summa’s high 2.94 MER (Ethical Growth sports a 2.38 MER) clearly doesn’t help.

According to the Jantzi social index, a grouping of 60 stocks chosen for their ethical practices and a key benchmark for ethical investing in Canada developed by Jantzi Research Inc. , SRI has almost kept pace with the overall Canadian stock market, outperforming the median Canadian equity fund at the same time.

The Summa and Ethical Growth funds have not, as yet, been able to do the same. For conscience-driven investors, a cheaper, passively managed fund, such as the $45-million Meritas Jantzi Social Index Fund, might be a better option. IE