How to reduce risk in your ethical portfolio

For ethical investors, watching the stock market plunge has been a stark reminder that even outstanding companies often follow the tide. So going forward, how can investors assess and manage the risks associated with stocks more effectively? Looking for answers, the Monitor's Laurent Belsie turned to two investment pros who deal with ethical investments: John DeSantis, president of Civic Capital Group in Boston, and Joe Clark, managing partner of Financial Enhancement Group in Indiana. (The views expressed here are for informational purposes and do not represent an endorsement by The Christian Science Monitor.)

Is the investment world suddenly riskier?

Mr. Clark: Yes, but not for the reason most people perceive.... If you step back and you look at the forest, and you understand that the generation that was born in the 1920s – we refer to [it] as the Bob Hope generation – for every one person that was born there, there were more than four people born in the baby boom. So for every one car we needed [then], we needed four [for the boomers]. For every teacher, four; for every hospital, four; for every doctor, four. And if you follow that logic then the risk follows later. The echo boom, the generation that followed the baby boom, is actually smaller than the baby boom. For every one person we have in the baby boom, there's about 0.95 people here. And so if you think about it, for every car we needed [for boomers], we now need 0.95. For every house, 0.95. America is not designed to contract.

Mr. DeSantis: One way of just observing the risk in the stock market is that commentators at the beginning of this year were talking about the increased frequency of 1 percent moves in the market. My last count so far in September, we've had four 3 percent down days. So that's just a little statistical observation one can make that yes, it's quite more volatile and a little bit more scary for the average investor.

Does federal intervention help or hurt?

Clark: It makes people less comfortable because they don't know the rules.... The risk is that if you do what you expect [the government to do] and the government does something different, your portfolio just got hurt.

Are socially responsible companies inherently less risky than the norm?

Clark: The interesting thing about companies that try to follow their social [conscience is] they give you a measuring stick out front. They say: We're going to do this, but we're also going to do this. And as an individual, you have the ability to look at that measuring stick and go, "OK, did they or did they not?" Here's the challenge. We're talking about the company. And what your real question is is about the stock price. Stocks go up [or down] based on one thing: Are people buying it or are they selling it?

DeSantis: It's absolutely a benefit to have an ethical component to the companies that you're investing in. And let me give you just one example.... Wells Fargo is a bank that's gone up in value this year. How's that when we read about the AIGs and the Fannie Maes and all the other horror stories in the financial press? The reason is, they've been in business for more than 150 years and they were started on the core concepts ... of trust and credible credit ratings and managing conservatively. So they're recognized within the circles as being a more prudent and ethical company. That has translated into gains for them and gains for shareholders.

Is it easier or harder to assess the risk of these firms as opposed to companies in general?

DeSantis: The difficulty is in the measuring. When you're measuring quantitative factors, like cash on the balance sheet, that's easy. You can't fudge that and you can measure it quite simply. When you're measuring the ethical component, it's more difficult. But it's [still] easy to do. We do it all the time in the grocery store. You buy tomatoes, you just don't pay attention to the price per pound. You pick up the tomato and you look at it. You look at the texture. So you get the same sort of analogy if you can go in and [investigate an ethical company].

How do you do it?

DeSantis: The same way you investigate your baby sitter before you hire a baby sitter. You do reference checks, you go visit the company, you talk to management, you talk to competitors within the field, vendors. How are they being treated? Everybody has a reputation. And that's pretty easy to ascertain.

If clients are worried about risk, where do you tell them to put their money right now?

Clark: Step back. Look at the forest. Say, "OK, this is the direction where things have to go...." When a government finds itself in an uncharted territory, an unhappy area, they do things like pulling infrastructure plays forward. We have 650,000 miles of water pipe in the United States; 30 percent of it in New York City was installed during the Lincoln administration. They're going to pull that forward – those kinds of jobs – forward to do some of that infrastructure play.

DeSantis: We take a view of looking within society at big problems and then what are the companies that are providing solutions to those problems. The advantage of that is that it's long term, it's sustainable. Issues of water are real and they've been around for a long time. I think it was a big theme in the Roman Empire, too. It will be a big theme next year.

What are three good places or companies to invest in?

Clark: Let's do the other side first. Will Rogers said: "Sometimes the return of my money is more important than the return on my money." The challenge when you get here is people start to hide.... When things get tough, governments lower interest rates. You can't go hide. Inflation will eat you alive. That goes to the diversification and that long-term planning. Go to food. People will eat. The consumers are not broke. Do not buy into that. It is not true at all. Wall Street has merely lost the ability to figure out where they're going to spend money next. I guarantee you they're going to eat. I guarantee you they're going to need healthcare. And I guarantee you that they're going to use different software devices to make their lives better – the gadgets, if you will, that really add to life.

DeSantis: I’ll start off with Unilever – for people who want a stable growth business. I think 50 percent of their growth now is from emerging markets where they’re doing a good job of educating people on hygiene and basic products. And they have a stable business. They’ve been in business a long time. They have a good dividend yield. And it gives you growth opportunity. For a little more risk-taking, there’s a local company called Metabolix. They’re a bioindustrial company. The concept there is that they make a biodegradable plastic that will be introduced in the country in the second quarter of 2009. And plastic is a pretty good problem.... About 8 out of every 10 plastic water bottles end up in a landfill somewhere. We know it’s a problem. It’s growing. And here’s a company that has a solution.