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Interview with Philip J Matyi, CFA, Civic Capital Group LLC

Civic Capital Group believes that many of the best future investment opportunities involve solving social problems. As a result, it invests in companies whose products or services have an immediate, positive impact on today’s major challenges in society, such as nutrition, education, medical care, environmental concerns, and the care and well-being of senior citizens. Investment decisions are driven by in-house fundamental and quantitative research with input from an advisory board of business and academic leaders. Rather than screen-out candidates for socially responsible investing (SRI), Civic is pro-active in identifying companies which address unmet needs of society.

Philip Matyi, CFA, is responsible for business development at Civic Capital Group. Prior to this, he spent 12 years with Independence Investments, initially as a management consultant and later as vice-president of institutional sales. His prior experience includes financial management as a corporate CFO, commercial banker and business management consultant. He graduated from The College of the Holy Cross University with a bachelor’s degree in economics. He is a member of the CFA Institute and The Boston Security Analysts Society.

John DeSantis, CFA, is the portfolio manager of Civic Capital Fund I. Prior to founding Civic Capital Group, he spent five years as executive vice-president and chairman of the investment committee at Independence Investments, the investment advisory subsidiary of John Hancock Financial Services. Prior to that, DeSantis was the firm’s director of research for nearly 12 years. At Independence, he was an active manager of the business spearheading the firm’s entry into international equities, tax sensitive products and hedge funds among other initiatives. He also managed portfolios ranging from as high as US$1 billion. He holds a BA in economics from Brown University and an MBA from Indiana University. He is a member of The Boston Economic Club, a past president of The Boston Security Analysts Society, and is also a member of the CFA Institute. He is the author of “Annual Report Trivia & Investable Trends”, a publication reflecting business, economic and social trends.

  1. Following an equity long/short strategy, Civic Capital takes a socially responsible approach as well. Can you elaborate on how these two (ie the analytical and ethical aspects) are combined into the management process?

    We deliberately chose a hedge fund vehicle for our product because we believe it offers the opportunity to concentrate stock specific risk as the primary source of returns while also offering the downside protection and opportunity to utilise the full scope of investment potential (ie potential to earn returns in both up and down markets).

    Our investment process begins with identifying problems in society, and the research into understanding the nature and scope of these problems. We seek problem areas with “drivers” for addressing the concern (eg rising and vocal public concern and pressure, governmental recognition of issues (eg aids, global warming, aging populations, education, etc). We receive input and suggestions about particulars in the area from our advisory board which is composed of industry “experts” in their fields.

    After selecting an area, utilising traditional, bottom-up fundamental research, we identify and evaluate companies whose products/services function in the area. We identify the best investment opportunities, and these become candidates for investing in our “long-side” portfolio. Since the “resolution” of these global problems is complex and rather large, the demand for successful solutions is, by nature, sustainable over time. No one company can resolve clean water, healthy environments, energy efficiency, etc, thus the demand for the products continues and grows over time. It is a “sustainable” product and demand.

    *As at 31 March 2008

  2. Can you elaborate in your investment approach, in particular your short-selling methodology? How does it take into consideration your SRI/Sustainable principles?

    The research into companies working in the area also provides a source for “shorting” candidates. While the best companies are candidates for the long side, some of the companies reviewed, demonstrate weaker competitive excellence, rich valuations, or declining products, and these companies become candidates for shorting.

    Once the long candidates are chosen, the overall long side is reviewed for concentrations and biases in industry, capitalisation, style, sectors, etc. Then short candidates are selected specifically to attempt to neutralise these biases (market risk).

    Because shorting is used in the most traditional definition, namely to “hedge-out risk”, we might also be referred to as a “hedged portfolio”. Shorting is used to reduce market and factor risk (eg biases in style, sector, industry, capitalisation, etc). This concentrates the “stock-specific risk” in the long portfolio, which risk, in turn, is closely linked with the product(s) produced. Thus, the source of alpha, in effect, becomes the unique product or service produced by the company. This opportunity to reduce market risk while concentrating specific stock risk is unique to a hedge fund vehicle. This is ideal for concentrating sustainable returns even more than a long-only portfolio.

    Many short ideas come out of the research into the various groups of companies serving the particular problem area. Some of the companies we identify will be weak competitors, or will be unable to adjust to the trend, or have reached lofty valuations, and become candidates for shorting. An example comes from our research into the trend towards healthier food consumption. Early in our history, we saw shelf-space in markets being converted more and more to healthy foods. Since there is a fixed amount of shelf space in food retailing, some products would get less shelf space, which would hurt their prospects. We bought healthy food producers and suppliers, and shorted high sugar and fat content products like Krispy-Kreme, Tootsie Roll, sugary sodas, and etc.

    We suggest that our product delivers more “social impact” for the invested dollar based on two aspects. Firstly, it is a result of the more concentrated dependence on the “stock specific risk” through our shorting process. Secondly, it is because a higher percentage of our holdings are pro-actively contributing to solving a particular problem of society. Virtually all our long holdings contribute to making a difference. In many traditional SRI portfolios which employ “negative screening” to select their investment universe, the successfully screened stocks all “do no harm” by not violating SRI precepts, but in some cases, they do not really make a positive impact. This is a passive contribution to the world condition. Because of our selection process (companies making a contribution), virtually all holdings make a positive impact.

    Additionally shorting is also used opportunistically outside of the “market risk dampening”. It should be pointed out that our process is not “buy the good guys (SRI compliant), and short the bad boys (non-compliant with SRI principles)”. Our short universe is all stocks, not simply stocks which do not make a social contribution. We short stocks based on their valuations and business prospects.

  3. The last decade has seen SRI funds evolve from a first generation of exclusionary screens, a second generation of positive screens, towards a third generation of all-encompassing criteria (ESG, CSR, etc). Where does your fund fit into this evolution?

    By virtue of our investment process (investing in companies making contributions to society), we probably fit more into the third generation. Our positive selection process usually avoids the kinds of conflicts which emanate from negative screening and non-ESG, and non-CSR compliance. However, before we make a final decision to invest in a firm, we have checked it against existing lists of non-compliant companies maintained by SRI and compliance monitors.

  4. With regards to the Civic Capital Fund’s portfolio, what is the average holding period of your investments and how liquid is the portfolio? How often do you turnover the portfolio?

    Our long portfolio, by virtue of the investment criteria and sustainable demand potential, is a longer term portfolio.

    Liquidity: 90% of the total portfolio can be liquidated within 1-3 days.

    The turnover over the past years has been about 40% on the long side, and, more than doubles that on the short side.

  5. How many positions do you run on average and how are these positions distributed between the long and short allocations? How often are these weights reviewed?

    On average there are between 65 and 85 long positions, and 45-65 short positions.

    The relative number of long positions is based on the opportunities they present, not a specific total portfolio dollar amount. The shorts are dictated relative to both the market risk in the long portfolio as well as opportunistic profitable trades. This balance is monitored daily by the portfolio manager to see that a reasonable relationship between longs and shorts is maintained.

  6. Across the board, SRI funds have had significant allocations to financial stocks (sometimes above 25%), and recent market turmoil has dented returns. Much of it started with unethical lending techniques in the sub-prime market. Will this have a lasting impact on how companies earn their ethical labels?

    Probably so.

    However, our exposure to the financial sector has been with large international banks which while affected by the impact on the industry, have not been the worst hit by this crisis.

  7. How has the fund performed vis-à-vis its investment objectives, over the months since its inception in July 2003? How would you rank the fund’s overall risk-return profile?

    The fund was established in 2003 with targeted net-of-fees returns in the high single digits with a lower risk than the overall market.

    So far, this has been met every year as follows:

    YearNet Return Standard Deviation (Annualized)
    2004 6.1%3.1%
    2005 8.1%3.83%
    2007 6.8%4.5%
    2008 through 30 May 1.2%4.6%

    The fund is a low volatility product focusing on downside protection. The goal is to provide competitive, risk-adjusted returns without taking the “return give-up” usually ascribed to SRI or “values investing”. This has been demonstrated particularly in the current markets. Civic Capital Fund’s return for the 12 mos. ended 30 May 2008 was 3.2%, while for the same period, many indices were down anywhere from 3% to 10%!

  8. What went right in your best monthly and yearly returns (+4.24% and +8.73% respectively) and your longest winning period (six months)? Can you put an estimate on the alpha-component of these returns?

    Our best returns occurred in relations to our investing in energy efficiency. One of our holdings was Pacific Ethanol, which was swept up in the publicity of Bill Gates’ making a significant investment in the company in November 2005, combined with the comments in the President’s State of the Union message in January 2006. This was the month of our highest performance. We currently hold only a small position in this company composed primarily of warrants attached to our original investment.

  9. The Eurekahedge SRI database monitors well over 700 ethical and/or sustainable funds in the long-only world. What, in your opinion, explains the limited offerings from the alternative industry? Is this due to a shortage of fund managers or a lack of demand from investors?

    The growth of SRI in the alternative space is in the traditional evolutionary process which exists for many “new” products. Usually there are a few early adopters, and the rest of the group takes a wait and see posture. Traditional hedge funds have been available for many years. However, over the past few years their popularity has grown geometrically. Currently SRI issues are becoming more and more mainstream as we hear of energy efficiency, “green” themes, climate change, clean water, etc. Endowments, foundations and other public and institutional plans are feeling pressure from their constituencies to increase their exposure to “green” and SRI investments. In Europe, some governments are mandating their public plans become entirely invested in “sustainable” investments.

    We see this as a great opportunity for us. As the traditional plans increase their exposure to hedge funds and the attractiveness of “sustainability” becomes a mantra, the demand for a hedged SRI product seems inevitable. Our 5-year track record should provide a great competitive advantage for investors seeking exposure to this space.

  10. Over the last few years funds with a thematic approach (environmental, climate change, renewable energy, etc) have emerged in both the conventional and alternative worlds. How is your fund’s proposition different from these?

    We are not as concentrated in our investments as they are. We offer a diversified broad selection of domestic and international investment themes. This is what helps us outperform in market like the recent months.

Contact Details
Philip J Matyi, CFA
Civic Capital Group LLC
(617) 451-1333