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Thou shalt comply with SRI

Hedge fund firms accepting screens to get faith-based business

Lisa Zuckerman
Lisa Zuckerman expects no long-term performance problems because of SRI screens.

Hedge fund managers hungry for institutional assets are increasingly willing to incorporate exclusionary screens into their investment approaches to keep portfolios in line with the socially responsible investment values of church-affiliated investors.

It was nearly impossible before the financial crisis of 2008-'09 to convince hedge fund managers to share the contents of their portfolios with investors, much less to apply any type of constraint to the managers' investment strategies.

But faith-based organizations are on a mission to construct hedge fund portfolios that use the same screens they've successfully applied to the rest of their portfolios.

Screens broadly used within the faith-based investing community exclude securities of companies that derive significant revenue from alcohol and tobacco products, pornography, gambling services, weapons manufacturers and service companies, products that induce abortions and abortion-related services.

U.S. faith-based investors that have added screened hedge fund portfolios in the past 18 months include: Dignity Health; Mercy Investment Services; Christian Brothers Investment Services; Felician Sisters of North America; Presbyterian Foundation; Ministers and Missionaries Benefit Board of the American Baptist Churches; and Ascension Health.

Because many faith-based organizations are reluctant to reveal the size of their overall investment pools much less the size of their newly minted SRI hedge fund portfolios, quantifying the trend in monetary terms is not possible.

However, “screening hedge funds for SRI is a really active area right now with more sophisticated faith-based investors,” said Laura Berry, executive director of the Interfaith Center on Corporate Responsibility, New York.

“I don't know a single faith-based chief investment officer who does not want to produce alpha for his or her fund. The question really is how to be sure hedge funds are producing alpha in ways that are consistent with the organization's mission,” Ms. Berry stressed.

The ICCR is a coalition of institutional investors that seek to integrate social values into investment actions.

Many hedge fund managers needed to be convinced that there would be demand for screened versions of their investment strategies offered as a separate share class or in a separate account format, said Jessica Matthews, associate director of the mission-related investing group of consultant Cambridge Associates LLC, Boston.

“Collaboration between faith-based investors has been very helpful. Strong peer networking has demonstrated for many hedge funds that there is indeed demand for these SRI strategies,” Ms. Matthews said.

Lisa Zuckerman, vice president-treasury services, Dignity Health, San Francisco, said: “We have been very collaborative with other faith-based investors, primarily our peer Catholic investors, on SRI-screened hedge funds. They often have followed us into screened hedge fund strategies.”

Dignity Health operates hospitals and ancillary health-care facilities. Most of Dignity's $7 billion of pension fund and operating pool assets are compliant with SRI investment principles, Ms. Zuckerman said.

Dignity Health spent the last year moving to direct investment in SRI-screened hedge funds from a fund-of-funds approach. Helping with the switch was manager-of-managers Strategic Investment Group, which was hired two years ago as an adviser and co-fiduciary for Dignity's entire investment portfolio.

Fully $800 million now is invested in diversified strategies run by 20 hedge fund managers that Ms. Zuckerman declined to name.

Ms. Zuckerman echoed other faith-based investors interviewed when she said she expects that over the long term, the performance of the hedge fund portfolio will not be negatively affected by the SRI screens. “Short term, the screens may impact individual strategies differently but over time, performance will even out,” she said.

Mercy Investment Services, St. Louis, which manages an undisclosed amount in SRI-screened long-term reserves, operating and endowment pools for the Sisters of Mercy religious order and its ministries, established its first full-fledged SRI-screened hedge fund portfolio in January.

“The sisters have been very active on the cutting edge of corporate activism and wanted to extend the same values to the hedge fund portfolio,” said Bryan J. Pini, chief investment officer.

Coming from an endowment-management background, hedge funds were no mystery to Mr. Pini but like other religious investors, Mr. Pini said he had to show that there is “a business model here for hedge fund managers willing to offer SRI portfolios. We believe that what we told managers — if they create these funds, the assets will come — is true, but still is in the very early stages.”

The Mercy portfolio has 12 hedge fund managers now and will add three or four managers to further diversify the portfolio over the next six to 12 months, Mr. Pini said, declining to name the managers or give the size of the hedge fund portfolio.

“We recognized that our small amount of money wouldn't change the world but we wanted to be on the leading edge of investing in SRI-screened hedge funds,” said Mark Schafale, chief financial and administrative officer, Felician Sisters of North America Inc., Beaver Falls, Pa.

Mr. Schafale declined to say how large the sisters' SRI-screened investment and pension pools are but noted that 10% of the assets were invested directly in single and multistrategy hedge funds in November 2011 with the assistance of Cambridge Associates.

Mr. Schafale has had better-than-expected success in finding hedge fund managers willing to apply exclusionary screens: The goal was to have 50% of the portfolio in SRI-compliant funds but already 62% of the current lineup uses screens.

“We are aiming for 100% SRI-screening but we didn't want `perfect' to get in the way of good. You have to dive in somewhere,” said Mr. Schafale.

Christian Brothers Investment Services Inc., New York, owned by the De LaSalle Christian Brothers, manages $4 billion for the order, its affiliates and other Catholic institutions. It opened its first SRI-screened hedge fund in 2005. The hedge fund of funds used two external managers and was closed in 2009 because of performance problems.

“The key takeaway was that our next hedge fund undertaking would not be something we would launch from scratch,” said Paul R. Ainslie, alternative investment specialist for the manager of managers.

Mr. Ainslie spent three years looking for existing SRI-compliant hedge funds with a proven track record and found BBT Capital Management LLC. Christian Brothers Investment Services acts as a subplacement agent for BBT Capital Management's SRI-screened hedge fund and has moved $23 million from Catholic institutions into the fund.

In addition, Christian Brothers Investment Services has established a proprietary SRI-screened hedge fund platform and BBT Capital Management's fund is “the first of a number of hedge funds we intend to add to our platform,” said Mr. Ainslie.

BBT Capital was asked to create an SRI-screened version of its multistrategy hedge fund by a group of Catholic institutional investors in 2005, said J. Kenneth McCarty, chief financial officer and head of investor relations of the Fort Worth, Texas-based firm. Mr. McCarty declined to name the investors.

“We analyzed the SRI screens and found that our strategy didn't have much exposure to restricted stocks and over time, have found that the screens have had little impact on performance compared to the regular version of the multistrategy fund,” Mr. McCarty said.

BBT Capital's SRI committee is made up of investors in the SRI version of the hedge fund, which now totals $400 million. Every six months, the committee provides a list of about 250 restricted stocks and bonds that BBT cannot invest in on the long or short side or even through derivatives.

“What I find very rewarding is that through our SRI hedge fund, we are able to make money for investors whose work with the poor, in education, in social justice matters just blows me away,” Mr. McCarty said.