April 9, 2003

By Peter Miguel Camejo

NOT LONG AGO , at my suggestion, the people who run Contra Costa County's $2.6 billion pension fund agreed to conduct a one-year test of what would happen if they adopted even modest policies against investing in companies with bad environmental records.

They hired Innovest, a firm specializing in environmentally friendly investment, to look at how a few basic "screens," or rules for choosing stocks, would affect the bottom line. The report is due out soon – and it will show how this socially responsible policy has also been fiscally responsible: with environmental screens, the county's portfolio is doing better.

Contra Costa is the first county in California to adopt a policy of environmentally sound investing. And there's a lesson here for individual investors all over the country.

When most people look for places to put their money, they follow the conventional wisdom: a socially responsible portfolio, they assume, must lead to lower financial returns. In fact, these investors are not only supporting the war industry, polluters, tobacco companies, and firms with criminal records such as Enron, they're also sacrificing their own financial gains.

The truth is, socially responsible investing (SRI) has consistently outperformed unscreened investments. Comparisons of indexes and mutual funds have repeatedly shown that caring about the environment or social justice gives investors a financial advantage.

Socially responsible screens lower risk by eliminating corporations with criminal records, bad community relations, and other factors that often come back to hurt them financially. Companies that make it through those screens tend to be run by stronger managers who avoid getting into costly social conflicts. The facts are clear: good business is good business.

Bush's bear market

But knowing that your financial health and the health of the world will be better by investing in a socially responsible manner doesn't answer the question of what to do after a three-year crushing bear market (from top to bottom the Nasdaq 100 dropped 84 percent and the S&P 500 45 percent), an amazing increase in corporate crime, and the wars of aggression and conquest by our government. Since 1999, SRI equity funds have gone down, along with all equity funds.

Is there any way to protect your savings, 401(k), or other investments from the effects of the U.S.-led war and the financial crisis surrounding capital markets? To answer that question, it's important to explore some of the key reasons why the stock market is in such bad shape.

Markets abhor uncertainty – and the current world crisis, including the U.S. invasion of Iraq and the geopolitical mess it's made, is changing the framework under which the global economy has functioned since World War II.

The U.S. government under President George W. Bush has decided to openly reject the structure of the rule of law in the international community. That decision is meeting massive opposition around the world. Bush's policies are now rejected, according to reliable polls, in every country of the world with the exception of Israel and the United States. The polls show figures of nearly 80 to 95 percent opposed to Bush's war in country after country.

The United States is also rejecting international agreements, from the Kyoto Protocol to the new World Court. In effect, it is declaring itself a rogue nation seeking through military power to restructure a world order to its liking.

In world markets this new U.S. policy has created such a high level of uncertainty that capital investment decisions have been postponed. Once capital investments have been curtailed, the world economy begins to slow, and a negative cycle of unemployment and declining demand sets in.

On top of the slowdown in economic activity, investment capital during a crisis tends to take flight to safety. This in turn further lowers interest rates. As a by-product of lower interest rates, homeowners refinance, which results in lower home payments (equivalent to an increase in pay) and a withdrawal of equity from their homes – both of which help stimulate the U.S. economy. But this stimulus will soon run out of steam. And a rise in the price of oil products is acting as a brake on economic activity.

To make matters worse, federal and state governments are facing massive deficits – and instead of covering costs by taxing the rich, they're cutting spending. In California a Democratic administration and legislature have created a massive deficit (estimated at $35 billion) during a period that saw income rise an amazing 50 percent.

Private-sector problems

While these governmental financial disasters were in the making, corporate managements have set out to rip off their shareholders, specifically pension funds and mutual funds, which between them now own 60 percent of the 1,000 largest public corporations.

Jeff Gates, onetime counsel to the U.S. Senate Finance Committee, estimates the amount stolen from the shareholders of major corporations such as Enron, World.Com, and General Electric at close to half a trillion dollars. This massive robbery is unparalleled in world history. It involves the CEOs, other top managers, boards of directors, their attorneys, and their accounting firms. Faking financial figures and manipulating markets are now recognized to be far more common occurrences than previously believed.

As a result, the public is losing confidence that the U.S. equity markets can be trusted. In fact, a huge transfer of wealth has taken place in the past couple of decades from the low- and middle-class public to a tiny minority of the super rich. For example, today in California one-third of 1 percent of the population receives 21 percent of the income. Bush wants to cut taxes to increase the disparity.

As the United States becomes increasingly isolated and its governmental deficits explode, the dollar is starting to weaken. The petrodollars of yesterday are now petro-euros. The war with Iraq is part of an effort by the United States to reverse these trends – to divide the Europeans through U.S. control of major oil reserves. Those policies might end up creating a more unified Europe, centered on France and Germany, with the Russians and Chinese allied to them.

Such a development conjures up the risks of trade wars and further conflicts as each side tries to improve its position. Third world countries fearing U.S. domination will try to play the two sides against each other to gain maneuverability. And of course, trade wars are quite negative for the markets and the economy.

Some good news

Before you decide to sell your mutual funds and hide your money under the mattress, let me warn you that while all of the above may be true, there are also some very powerful forces opposed to the direction Bush is taking the world.

There has never been such a massive consensus of humanity as we now see in the opposition registered against Bush's war. If Bush's policies are derailed, it could have a positive effect on the world economy.

Besides, the stock market is a discounting mechanism – and it may, to a great extent, have already priced in all of these fears and dangers, and thus any move that ameliorates the present crisis could lead to an explosive equity market rally.

Remember the market is driven by the two major emotional errors: greed and fear. The smart, socially conscious investor should avoid both.

My advice for how to handle your money under these conditions is to take a few steps aimed at providing some safety but also to keep your vision balanced between the dangers and the counterforces at work.

If you have a little extra to invest, first pay off your credit cards, or build up a reserve in low-return CDs, or lower your home mortgage. Second, learn what an asset allocation is and make sure your 401(k) or whatever you have is in an allocation appropriate for you.

There is nothing you can do to protect yourself financially against catastrophic disaster – say, an atomic bomb going off in a major U.S. city – except perhaps buying some gold coins and taking delivery of them. Gold has been in a 20-year bear market that seems to have just ended. The long-term trend lines are now broken on the upside, and gold might just be a reasonable investment anyway. For some time I have been recommending that people invest 2 or 3 percent of their net worth in gold coins.

Of course, U.S. treasury bills, notes, and bonds can be considered nominally safe – as long as the U.S. government exists, it can print money and pay off treasury obligations – but they may be hurt by inflation. If the value of the dollar drops, the relative value of treasury obligations also drops.

While it may be prudent to have some exposure to the equities markets, talented financial prognosticators, including San Francisco's bond guru Bill Gross, don't think so, and they just might be right. Fortunately, there are some "chicken" ways to play the stock market using hybrid instruments that have the safety of corporate bonds (Gross thinks that's where one should invest) and the returns that come with equities. They are called index notes. Convertible bonds, if picked very, very carefully, can provide the same scenario of combined safety of principal and equity type upside potential.

Few investments prosper in a crisis. One exception, which I have advised many of my clients to consider, works in general but especially when instability increases. It's called managed futures.

Essentially, managed futures are a form of insurance for economic transactions involving things such as currency and interest-rate hedging. As long as the markets are moving strongly in one direction, managed futures work. In moments of crisis, trends become pronounced and managed futures can provide high returns – as they have in the last period. Like equity mutual funds, managed futures do involve risks. But I'll stick my neck out here and suggest that for a period, say, the next 10 years, this category of investing is going to stand out as a big winner.

The largest managed futures firm, Campbell, has had lower volatility or risk than the stock market as a whole over the past 30 years and yet achieved a net 17 percent a year return of all fees to clients over this period of time. This is substantially above equity return.

Managed futures, like car insurance, are essentially socially neutral – in fact, they can help lower prices for consumers and allow farmers and third world countries to participate in the global market without intolerable risks.

(Nothing in this article should be considered a recommendation or advice regarding any specific investment. Many of the investment products mentioned here require a prospectus before investing. You should work with professional advisors to make sure any investment is appropriate for you as an individual.)

Have we hit bottom?

A lot of technical indicators are pointing to a possible bottom in the stock market. Even if we are in a long-term bear market, an important market rally sometime soon seems likely.

Longer term, if the world crisis declines and the United States moves toward accepting an international rule of law (with Bush becoming a one-term president), the economy and market could experience a strong stimulus. It's already priced in the instability. Nothing says it can't go the other way.

If you have equity investments, I suggest you shift them toward mid- and small-cap funds or companies, to avoid the large corporate governance issue. Stick to socially responsible funds, in which the dangers of corporate crime are somewhat reduced. If you have a sophisticated broker, sell your appreciation potentials in at least part of your equity positions by writing covered calls.

The solar solution

One investment that has a rather good return and should work for homeowners and businesses is solar energy. This is mainly due to the rebate and tax advantage programs in California.

For homeowners, converting to solar as a source of electricity is roughly the equivalent of an investment return of about 6 to 8 percent tax free. The best way for homeowners to finance solar energy is through their mortgage or a home-equity line of credit. These have now reached rates unseen in 40 years (go to our Web site www.cagreenlight.com for financing assistance – we welcome all providers of solar installations to take advantage of our financing program at no charge).

The return for businesses installing solar can be higher because they benefit from accelerated depreciation and state and federal tax credits. Third-party financing for solar can provide relatively high returns (an interest-rate return of 10 to 15 percent) for accredited investors who have a high tax rate, because of tax credits and accelerated depreciation, along with cash flow generated by the solar installations.

Investing in alternative energy companies has a great potential, but it's hard to get it right. Jack Robinson of Massachusetts is a strong advocate of alternative energy and a money manager who has successfully focused on green growth potential. There are many others listed in the excellent book, Investing with Your Values, by Cliff Feigenbaum, Hall Brill, and Jack A. Brill.

The key to investing today, as always, is establishing an appropriate asset allocation and having a long-term discipline. And socially responsible investing as a philosophy that can be used in almost any class of investments makes more sense now than ever.