Where's your piggy going to market? The dividends of faith-based investing.

During his 25 years of investing in the markets, Paul McInerny had never given much thought to what his Catholic beliefs had to do with his portfolio. McInerny, president of Dominican High School in Whitefish Bay, Wisconsin, and his wife, Carol, a certified public accountant, were saving for their retirement and their kids' college education. Reaping the best possible returns on their investments was their No. 1 goal--something that wasn't hard to do during the bull market of the late 1990s.

Like most investors, McInerny's portfolio growth slowed considerably after the market downturn that began in 2000. As the economy slid toward recession and stories about massive layoffs and shrinking retirement plans dominated the news, the McInernys started to look beyond their bottom line. Both were troubled by the fact that workers almost everywhere were worried about job security and their financial futures while top executives, embroiled in corporate wrongdoing, reaped fortunes. Around this time, the couple discovered the Catholic Funds, a Milwaukee-based mutual fund company that invests according to Catholic principles. The firm focuses on the church's social teachings regarding labor and workplace justice.

"When we heard about the Catholic Funds, we said to each other, `This really makes sense,' "he says. "We realized we needed to put our money behind our values." Almost three years of rough market performance later, the couple now has a regular amount automatically withdrawn every month from their bank account and invested in the Catholic Equity Fund.

"When we look at some of the things that have happened in the corporate world since we started investing in the Catholic Funds, we're even more convinced that we did the right thing," McInerny says.

The coed Catholic high school he heads has moved 20 percent of its modest endowment into the Catholic Equity Fund as well. "When we meet with donors, we tell them that as our endowment grows, we plan to invest it in a socially responsible way," he says.

Many investors get into the stock market to reach the same financial goals as the McInernys. But also like them, not everyone is comfortable supporting a company just because it delivers good returns--people want to know how it does business. Does it pollute the environment? Sell alcohol, tobacco, or weapons? Have practices that discriminate? Some investors would rather not profit from corporate practices that conflict with their values. In fact, the U.S. bishops have called on all Catholic shareholders--individuals and institutions alike--to make sure their money is invested in a morally responsible manner, while acknowledging that investors have a right to seek an adequate return on their investments.

So how do Catholics go about reconciling profit with principles? Investing in a way that fully reflects the Catholic faith is no easy task. Unlike many other socially responsible investors, Catholic investors are challenged to address a wide gamut of concerns, from abortion to military spending to discrimination. The U.S. bishops have provided investing guidelines, but many Catholic investors and asset managers have found very different ways to invest according to their beliefs.

The roots of responsible investing

Investing according to religious beliefs is nothing new. Ancient Jewish laws dictated rules for morally responsible investing. In the 1800s, the Quakers, who were pacifists, avoided investing in weapons production.

Socially responsible investing gained prominence with the general public in the 1970s as activism raised social consciousness on many issues. In particular, some investors didn't want to support companies that profited from the Vietnam War. Environmental practices and workplace policies also became popular areas of concern for investors.

It was in this climate that the first socially responsible mutual funds were launched for individual investors. In 1971 Pax World Fund became the first broadly diversified fund to use social and financial criteria in investment decisions, avoiding companies involved in defense and weaponry, tobacco, alcohol, and gambling. The fund now has more than $1 billion in assets. Similar funds soon followed, including Domini Social Equity Fund and Calvert Social Investment Fund.

The second recent boon to the socially responsible investing movement occurred with the groundswell of investor opposition to South African apartheid in the 1980s. More and more companies stopped doing business there because of pressure from shareholders, and as a result, the apartheid government was ultimately defeated.

Successes like these have helped socially responsible investing move closer to the mainstream. According to the Social Investment Forum, a national nonprofit association that promotes socially responsible investing, assets in socially screened portfolios now account for more than $2 trillion of the almost $20 trillion in professionally managed investment assets in the United States.

Conflicting criteria

The principles followed by socially responsible investors vary widely--and sometimes even contradict each other. Some may only invest in companies with positive policies, such as progressive hiring practices or good product-safety records. Others may avoid companies in objectionable industries, such as gaming or nuclear power. Some investment criteria are founded on religious beliefs; others on secular ideals.

So how are Catholics supposed to morally invest?

In his 1991 social encyclical Centesimus Annus, Pope John Paul II wrote, "Profit is a regulator of the life of a business, but it is not the only one; other human and moral factors must also be considered, which in the long term are at least equally important for the life of a business."

That same year, the U.S. bishops came out with their "Socially Responsible Investment Guidelines" for their own bishops' conference to use in structuring its portfolios. Catholic institutions and individuals also use it for guidance.

The bishops stated that they must exercise responsible financial stewardship over their economic resources as well as ethical and social stewardship in their investment policies. They based their guidelines in part on an earlier pastoral letter, Economic Justice for All, which states "individual Christians who are shareholders and those responsible within church institutions that own stocks in U.S. corporations must see to it that the invested funds are used responsibly."

Their key areas of concern include abortion, contraception, military spending and nuclear armaments, affordable housing (with regard to banking practices), and discrimination based on race and sex. They suggest three ways to invest responsibly with regard to these issues: refuse to invest in companies whose products or policies run counter to Catholic teachings, invest in companies that reflect and promote Catholic values, and advocate for change within a company through shareholder activism.

Economic Justice for All also mentions many other issues that Catholics could feel compelled to incorporate into their investing criteria, including the environment and labor relations.

Where does an average investor--who just wants to save up for that first home, the kids' college, or a comfortable retirement--begin?

Prolife and profitable

Evaluating investments using both financial and moral criteria can be tricky, and many investors leave it up to the pros. Mutual funds typically make up the bulk of the average individual investor's portfolio. So for some, socially responsible mutual funds that follow a defined set of standards when making stock selections are the answer.

According to the Social Investment Forum, there are now 230 mutual funds in the U.S. that incorporate social criteria in the investment process. Retail social funds manage about $11 billion in combined assets, a small fraction of the multi-trillion-dollar fund universe. Likewise, mutual funds that use religious criteria represent a very small slice of that fraction, but there are funds for investors of most faiths. Half a dozen of them are guided by Catholic principles--and they're as diverse as the social investing spectrum.

Among all socially responsible funds, tobacco is the most widely Used criterion. Among Catholic funds, the only common thread is an opposition to abortion.

One such fund is the Ave Maria Catholic Values Fund, based in Bloomfield Hills, Michigan, which applies a straightforward screen to its portfolio, excluding any company that is involved in abortion. That would include pharmaceutical companies, medical-device firms, insurance companies that finance elective abortions, companies that conduct fetal-tissue research, and companies that make contributions to abortion rights groups. The fund applies the same screening approach to companies that produce or distribute birth control and pornography, and those that provide domestic-partner benefits.

The Ave Maria Catholic Values Fund is the latest newcomer to Catholic investing. Launched in May 2001, the fund grew to more than $40 million before its first anniversary. The moral criteria of the fund are determined by an advisory board of prominent conservative lay Catholics, including former baseball commissioner Bowie Kuhn, activist Phyllis Schlafly, and Domino's Pizza founder Tom Monaghan, who came up with the idea for the fund and assembled the advisory board.

The fund's portfolio manager, Greg Watkins, doesn't feel the screens limit the fund's performance potential. "We look at a universe of about 2,000 companies. Our screens only eliminate about 10 to 15 percent of them," he says. "It isn't hard to put together a portfolio of 50 stocks from that. I'm not worried about the ones I can't buy."

But what stocks are excluded by the screens? Almost all big pharmaceuticals; Wal-Mart, which sells contraceptives; and companies that give benefits to unmarried couples or same-sex partners, such as American Express, Dell Computer, Eastman Kodak, Coca-Cola, and American Airlines. Although the U.S. bishops' guidelines make no mention of unmarried domestic partners, the fund's advisory board believes extending benefits to those couples undermines the sacrament of marriage, Watkins says.

He explains that the board members decided to restrict the criteria to what they believe are the core principles of the church. "You have to draw the line somewhere because you can carry it to a ridiculous extreme," he says. For example, even though Economic Justice for All calls for an end to massive military spending, the church recognizes there is such a thing as a just war, Watkins says. Therefore, the fund would not exclude defense companies.

Watkins concedes that the fund's decisions are subjective and not every Catholic will agree with them. "The fund is designed for investors whose concerns mirror the criteria we've established," he says.

But the McInernys, and many other Catholic investors, feel compelled to follow a broader spectrum of the church's principles on social justice.

"Catholic social teaching on the workplace is very clear," says Dan Steininger, chairman of the Catholic Funds. "It's a wonderful and important guideline to have." Catholic Funds evaluates companies on their workplace policies to ensure that working conditions are safe and pay structures are fair. In the wake of corporate governance scandals that have decimated many portfolios and left scores of employees out of work, the fund also keeps an eye on those issues, making sure the boards of directors serve as the corporate conscience.

"We know that you can treat employees with decency and still run a successful business," Steininger says. "We're fighting for things that truly affect everybody."

Put your mouth where your money is

Some Catholic investors feel the approach taken by Ave Maria Catholic Values falls short of fully implementing the guidelines set forth by the U.S. bishops in other ways. Capuchin Father Michael Crosby, a Milwaukee-based activist for socially responsible investing, is one of them. Crosby has been urging the Catholic community to directly advocate for corporate change since 1973, and he disagrees with excluding objectionable companies from investment.

"You can't preach the gospel if you have no voice," Crosby says. "There is much greater value in investing in a company and having the ability to address it directly."

In fact, the U.S. bishops have suggested that investors may be remiss by not engaging in active participation. "Failure to vote in such situations or assigning proxies to management is effectively counted as a vote for current management and the status quo," they write. The guidelines suggest "initiating and supporting shareholder resolutions, working with various religious and other groups who are working for corporate responsibility, writing letters to corporate executives and board members to advocate specific steps or to support or raise objections to a corporation's activities or policies."

While funds like the Ave Maria Catholic Values Fund screen their portfolios and exclude objectionable stocks, values-based mutual funds are increasingly adopting a strategy of shareholder advocacy to change company practices from within. Assets in portfolios that use both social screening and shareholder advocacy doubled from 1999 to 2001. That change in strategy is reflected in Catholic investing as well.

The Catholic Funds recently made the switch to advocacy in its investment approach. The firm used to offer three screened equity funds (Catholic Equity Income, Catholic Large Cap Growth, and Catholic Disciplined Capital Appreciation) to both individual and institutional investors, but it rolled the three funds into one new fund this year. The new fund is essentially an S&P 500 index fund, except it excludes companies that directly participate in abortion. The firm will advocate for change in any other S&P 500 company that they see as having unfair workplace policies but decided that abortion was one area where they didn't think they could do effective advocacy.

The first retail mutual funds for Catholic investors--launched in 1994--have always taken an advocacy approach. The Dallas-based Aquinas Funds--which include Aquinas Small-Cap, Aquinas Growth, Aquinas Value, and Aquinas Fixed-Income--will buy any stock that looks attractive from an investment standpoint. If, after owning the stock, the firm has a moral objection to the company's products, services, or practices, they then begin to advocate for change. The only company they won't invest in is Playboy Enterprises. The firm feels that there is no way they could change that business without eliminating it altogether.

The moral criteria of the Aquinas Funds follow the bishops' guidelines to the letter. The strategy of the firm is to persuade companies that addressing these issues will positively impact the bottom line. For example, when the Aquinas Funds invested in General Electric, no women held any of the top 150 positions in the company. The firm argued that the company could be subject to costly gender discrimination lawsuits. Nine months after discussions with the company began, GE promoted the first woman into one of those spots.

But, according to Frank Rauscher, president of Aquinas Funds, change doesn't always happen that quickly. "We tell our shareholders that they need to have patience," he says. "It might take years to see real progress."

Sometimes, though, the firm has to give up on certain companies and divest the stock. After two years of trying to persuade American Home Products to stop doing contraceptive research, the Aquinas Funds sold their holdings in the company.

Still, Rauscher has seen promising progress over the past decade. "Social investing itself has really caught on in the past 10 years," he says. "Our client base continues to grow, especially through 401(k) and 403(b) plans offered through Catholic institutions." The firm now has $175 million in total assets. The declining stock market of the past two years took its toll on the funds' assets, but new money is still coming in, he says.

Rauscher hopes that new Catholic funds will appear. "Education is the key," he says. "The more funds that are out there, the more investors will become aware of what we're trying to do."

Lobbying for change

But Catholic investors aren't limited to mutual funds if they want to invest according to their faith. Crosby believes that while investing in Catholic-oriented mutual funds is a step in the right direction, being a direct shareholder of a company is more effective. "The problem with mutual funds is you still lose your voice," he says. "The mutual fund decides for you."

Crosby works with the Interfaith Center on Corporate Responsibility in New York, directing their efforts on tobacco issues. The ICCR is a nonprofit coalition of 275 Catholic, Protestant, and Jewish institutional investors that manage more than $100 billion in assets.

Members of the ICCR include denominations, religious communities, pension funds, healthcare corporations, foundations, and dioceses. These investors collectively lobby companies to change what they believe are unjust corporate policies. Some of their priorities include eliminating sweatshops, reversing global warming, guaranteeing equal employment opportunities, making healthcare affordable for all, and ending tobacco product advertising. Their activities include initiating shareholder resolutions, meeting with management, publishing special reports, and sponsoring actions such as prayer vigils, letter-writing campaigns, and consumer boycotts. (Visit www.iccr.org to find a regional group near you.)

While more than 200 Catholic religious orders and institutions belong to the ICCR, fewer than 10 dioceses are members. Dioceses may be doing faith-based investing on their own, but Crosby is disappointed the bishops aren't doing more to follow their own guidelines. After all, Crosby says, "the ICCR is the only game in town," and they're not a big part of it.

While some Catholic institutions such as dioceses invest through mutual funds, the bulk of them employ secular financial advisory firms who use separately managed accounts for these sizable portfolios. For this reason, it is hard to quantify how much Catholic investors have in total assets.

Carlisle Social Investments in Kennewick, Washington is one of the few asset management firms that cater exclusively to Catholic institutions seeking separately managed accounts. It currently has $6.5 million in assets. Christian Brothers Investment Services, based in New York, is another investment advisor that offers both socially responsible managed accounts and mutual funds for Catholic institutions. It has more than $2 billion in assets.

Does it make a difference?

Can a relatively small but committed number of investors have an effect on large corporations and actually change the way they do business? Evidence suggests that they can. More and more companies are developing codes of ethics and mission statements, outlining values to guide the practices of its employees. More companies are also recognizing the needs of their employees and the communities they do business in--donating to charitable causes, creating family-friendly programs, and going beyond legal environmental protection requirements. The bottom line is companies are realizing social responsibility pays real dividends.

Mercy Sister Patricia Wolf, executive director of the Interfaith Center on Corporate Responsibility, attributes much of this attitude change to the persistence of values-based investors over the past 30 years. "Because of the determination of investors of faith to bring social concerns before companies, the broader investment community has learned it makes financial sense to be ethical," Wolf says. In the 1970s pursuing social concerns through shareholder proxy votes was unusual. "Today it's commonplace," she says.

The next step is broadening the base of socially concerned individual investors. The challenge there is that individuals must realize that social change comes slowly and requires patience. The current climate can also make caring about some issues difficult. For example, "having a conversation about investing in military weaponry is difficult post-September 11," Wolf says.

Watkins of Ave Maria Catholic Values Fund contends that investors shouldn't regard corporations as the bad guy. "Companies are responsible to the shareholders and, without any direction, they have to do everything they can to give them the best return on their investment," Watkins says. "Shareholders have to provide the moral direction."

The bottom line

One of the biggest obstacles to attracting more socially responsible investors is the belief that using moral criteria to judge investments will limit returns.

"Many funds like ours have proven they can provide competitive performance," Watkins says. "We're a Catholic values fund, not a Catholic martyrs fund."

Like all mutual funds, the performance of socially responsible funds depends on the performance of the stocks they own. And like all mutual funds, portfolio managers are paid to limit the universe of stocks to a profitable portfolio.

If you only want the highest returns, however, there's no reason to buy socially responsible investments. Most financial experts would agree that decision should be based on religious or ethical reasons.

It's hard to gauge the performance of socially responsible funds as a group, says Catherine Hickey, an analyst at the Chicago-based mutual fund research firm Morningstar Inc. "They're all over the map, but some have done quite well."

"This is still an investment," she says, "not a donation to charity." Hickey reminds Catholic investors to evaluate past performance, the manager's experience, and how the investment fits into their overall portfolios. She also cautions that, because religious mutual funds are usually run by small firms, they may not have the same research and analytic resources that large fund companies do.

Because there are two layers of research--one for investment potential and one for social criteria--these funds tend to be more expensive. Investors should look carefully at a fund's expense ratio and factor that into its returns.

The advent of socially responsible stock indexes has made it easier for investors to compare how a fund is performing relative to its segment of the market. The Domini 400 Social Index and the Calvert Social Index are two benchmarks to use when comparing social funds.

Carlisle Social Investments, which advises Catholic institutions, has developed two Catholic stock indexes: the Carlisle Catholic U.S. Market Index to represent the total U.S. stock market and the Carlisle Catholic Small Cap Index to represent the U.S. small cap market. Carlisle follows the investing guidelines of the U.S. bishops and does both screening and shareholder advocacy. In 2001, the Carlisle Catholic U.S. Market Index posted at a loss of 11.32 percent, compared with the Russell 3000 that was down 11.46 percent. The Carlisle Catholic Small Cap Index posted a 0.87 percent gain in 2001, compared with the Russell 2000, up 2.49 percent, and the S&P 600, up 6.54 percent.

Investors have a responsibility to themselves to do careful research and seek out the best return. Catholic investors now have more resources, guidance, and opportunities to do just that--and still invest according to their beliefs. Living out one's faith isn't easy, and neither is investing responsibly. The trick is finding ways that reflect one's own faith values and priorities.

Financial experts often advise a long-term buy-and-hold approach to investments, which has proven to be a profitable strategy. The same can be said of investing for the future of society. The race is long and progress slow, but investors can see great returns in the end.

FUNDS WITH A CONSCIENCE

Retail mutual funds that invest according
to their interpretation of Catholic principles:

AVE MARIA CATHOLIC VALUES (AVEMX)
Phone: [phone]
Web site: www.avemariafund.com
Load: 1% deferred load
Minimum investment: $1,000
Expense ratio: 1.5%
Year-to-date: -11.43%
Top holdings: Snap-On, Fortune Brands, Charter
One Financial, CenturyTel

AQUINAS SMALL-CAP (AQBLX)
Phone: [phone]
Web site: www.aquinasfunds.com
Load: No load
Minimum investment: $500
Expense ratio: 1.5%
1-year return: -15.27%
3-year annualized return: -12.66%
5-year annualized return: -6.10%
Top holdings: Biovail Corporation, Medicis
Pharmaceutical, Bisys Group

AQUINAS GROWTH (AQEGX)
Phone: [phone]
Web site: www.aquinasfunds.com
Load: No load
Minimum investment: $500
Expense ratio: 1.5%
1-year return: -10.38%
3-year annualized return: -7.52%
5-year annualized return: -0.19%

Top holdings: Microsoft, Concord EFS, Tyco International,
General Electric

AQUINAS VALUE (AQEIX)
Phone: [phone]
Web site: www.aquinasfunds.com
Load: No load
Minimum investment: $500
Expense ratio: 1.38%
1-year return: -8.54%
3-year annualized return: -10.18%
5-year annualized return: -5.23%
Top holdings: Citigroup, Bank of America, Kimberly-Clark,
ChevronTexaco, Lowe's

AQUINAS FIXED-INCOME (AQFIX)
Phone: [phone]
Web site: www.aquinasfunds.com
Load: No load
Minimum investment: $500
Expense ratio: 1%
1-year return: 5.81%
3-year annualized return: 7.36%
5-year annualized return: 6.04%
Top holdings: Ford Motor Credit U.S. Treasury
notes, Coca-Cola Enterprises, WorldCom

CATHOLIC EQUITY (CTHQX)
Phone: [phone]
Web site: www.catholicknights.com
Load: up to 4%
Minimum investment: $1,000
Expense ratio: .95%
YTD (As of 8/30/02): -20.72%
Top holdings: S&P 500 Index

Other socially responsible mutual funds:

DOMINI SOCIAL EQUITY (DSEFX)
Phone: [phone]
Web site: www.domini.com
Load: No load
Minimum investment: $1,000
Expense ratio: 0.93%
1-year return: -11.81%
3-year annualized return: -13.52%
5-year annualized return: -1.41%
Top holdings: Microsoft, Intel, Johnson &
Johnson, American International Group

CALVERT SOCIAL INVESTMENT EQUITY (CSIEX)
Phone: [phone]
Web site: www.calvert.com
Load: 4.75%
Minimum investment: $1,000
Expense ratio: 1.13%
1-year return: -2.72%
3-year annualized return: 1.24%
5-year annualized return: 3.02%
Top holdings: Avon Products, Questar, EOG
Resources, Pfizer

PAX WORLD GROWTH (PXWGX)
Phone: [phone]
Web site: www.paxfunds.com
Load: No load
Minimum investment: $250
Expense ratio: 1.56%
1-year return: -14.39%
3-year annualized return: -13.64%
5-year annualized return: -7.07%
Top holdings: Family Dollar Stores, Express
Scripts, United Parcel Services, Caremark Rx

(Data through 9/24/02. Fund performance is evaluated based on the
1-year return and 3-year and 5-year annualized returns, with the
exception of new funds Ave Maria Catholic Values and Catholic Equity,
which show year-to-date return.)

JENNIFER HOPFINGER is a financial journalist based in Chicago.