Wall Street Banks: Too Big to ... Invest in?

Why one fund refuses to invest in them.

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In the aftermath of the financial sector’s implosion during the downturn, many have been quick to say that investing in large banks is almost like spinning a roulette wheel. For the Appleseed mutual fund, that simile has just taken on newfound importance. Appleseed, a top-performing fund known for its socially responsible focus, has announced that it will bar itself from investing in too big to fail banks.

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With that restriction in place, the fund will now treat these banks the same way as it treats casinos, weapons companies, tobacco manufacturers, and pornography producers: as investments that it won’t consider under any circumstances. For Adam Strauss, a comanager of the fund, the decision is a response to perceived shortcomings in the ongoing overhaul of the financial sector.

[See 8 Great Socially Responsible Funds.]

“It does some things that are very good, but what it doesn’t do is reform the financial system to prevent a crisis like what occurred in 2008 and 2009 from occurring again,” he says. In particular, Strauss faults the federal government for failing to break up the too big to fail banks. “We think that having [these] banks continue to exist and operate … represents a systemic risk that should be avoided,” he says.

Or, as the fund put it in its press release: “The cost of bailing out Wall Street since 2008 is over $3 trillion, or more than $20,000 per taxpayer, and that cost is increasing daily. The financial burden of that bailout will be felt for a generation and will be paid by children, some not yet born. … U.S. policies and regulations favor the largest banks, which have proven themselves incapable of fiscal rectitude.”

By and large, Appleseed develops its screens to coincide with the ethical preferences of its investors. But are Wall Street’s synthetic derivatives really the moral equivalent of pornographic movies or machine guns? For many Americans, the answer appears to be an overwhelming “yes.”

“[We have] investors who would rather not own companies that make tobacco or operate in countries like Sudan,” says Strauss. “And similarly we’ve got investors who all things being equal would not like to own the too big to fail banks.”

For the most part, though, Appleseed’s too big to fail announcement is purely symbolic. That’s because the fund doesn’t own any too big to fail banks and hasn’t since it dumped Citigroup in 2007. As a result, the new restriction won’t prompt it to realign its portfolio in any way.

So why even bother with the announcement? “There are a lot of value investors that have started to invest in too big to fail banks, and we wanted to ensure investors that we were planning on avoiding them until we felt that there was meaningful-enough reform,” says Strauss.

In announcing the change, Appleseed said it would retain the ability to invest in community and regional banks. But it doesn’t own any of those now either and has no plans to add any to its portfolio. “The short–term outlook [for these banks] looks pretty poor,” says Strauss.

Even as socially responsible investing gains traction in the marketplace, common wisdom still dictates that funds that tie their hands by mixing ethics with financial decisions will often have to accept lower returns. Appleseed, however, has managed to shatter that perception: Over the trailing three-year period, it has outperformed the S&P 500 by a stunning 13.3 percent per year.