Morningstar Magazine - December 2017/January 2018 - 65

Another aspect of the research assesses
how companies respond to controversies. Top-10
holding Compagnie de Saint-Gobain SGO:FR,
a French cement and glass-making industrial
conglomerate, was enmeshed in a water-pollution
scandal in upstate New York originating from
the manufacture of Teflon. For Domini, the
question was how the company handled the
response, Petion says: "How did they react
when the contamination appeared, what did they
do to try and mitigate it, were they combative
or were they supportive?" In the end,
Domini decided that Saint-Gobain's response
was sufficient to keep the company on the eligible
securities list.
For some companies, the impact analysis
ends up being largely neutral, which still allows
them a place on the eligible securities
list. Altogether, at midyear, there were just north
of 800 stocks on the potential buy list sent
to Wellington.
At that point, the investment analysis stage
of the process kicks in. This division of labor
insulates the ESG research from potential
pressure to greenlight companies for the eligible
list just because they might be a hot stock.
"I'm making a decision based on whether
or not a company is sustainable and meets our
goals," says Petion, "not whether or not I think
it will outperform."

While the models are complex, Elliott says there
are three main pillars: momentum, value,
and quality. "These three are very different animals,
so you get a great diversification benefit. We
provide a smoother ride to fund shareholders by
combining factors, rather than just being
value or momentum investors. You might have
higher highs using a single theme, but you'd
also have to endure very difficult stretches [when
that one factor is out of favor]."
Elliott says that applying a quant process to
Domini's list of eligible stocks isn't much different
than applying it to, say, a list of stocks selected
by market capitalization. In this case, though, there
is a potential for portfolio tilts caused by industry
representation in Domini's eligible list-
such as the exclusion of fossil fuel producers.
Wellington uses risk models to identify stocks with
similar characteristics, thus mitigating tracking
error against the MSCI EAFE.
The fund's performance has indeed been highly
correlated with that of the MSCI EAFE index,
and it has also been competitive despite expenses
that rank as High within the fund's Morningstar
fee level group. Since the fund's inception
in late 2006 through October, the investor shares
have returned an annualized 2.4%, compared
with 2.6% for the benchmark. Over the trailing five
years, the fund has shown a pronounced
outperformance of 11.0%, versus 8.5%.

Picking the Winners

Adding Value

David Elliott, co-director of quantitative investments at Boston-based Wellington, has
overseen this portfolio since 2009. He notes
that Wellington will occasionally provide
feedback to Domini on potential areas of the
market where it thinks it doesn't have large
numbers of stocks to pick from. But for the most
part, "contact is limited," says Elliott.
"It allows each team to do what it does best."

The portfolio hovers on the border between
large-value and large-blend, and the fund
is currently placed within the foreign large-value
Morningstar Category. Its returns have beaten
more than 95% of these competitors for the trailing
three and five years through October, and
85% of those peers for the past decade. The fund
also looks strong against the large-blend
category, with a 1.6% 10-year annualized return,
compared with 1.0% for the foreign largeblend category.

Wellington's job is to apply a multifactor
set of models that employs dozens of metrics
to help predict which stocks will outperform.
Part of the process for developing the
models includes an effort to understand why
certain factors work, including the biases
introduced by human behavior.

The fund's average weighted market cap of
$15 billion is less than half that of its benchmark
or average peer, both of which have much
less exposure to small- and mid-cap stocks. That
may partly account for its outperformance,

as smaller-cap foreign stocks have generally
outperformed larger caps over the past
decade. That said, the fund has not been unduly
volatile compared with large-cap peers: Over
shorter- and longer-term periods, its standard
deviation has been on par with the norm, and its
5-star Morningstar Rating at the end of October
stems from high returns within its category paired
with average Morningstar risk scores.
It's also clear that Wellington's models have
contributed to the outperformance. The
fund is also tracked against a Domini benchmark
designed to match the risk and performance
characteristics of the MSCI EAFE, but populated
by the stocks in Domini's eligible stock list.
"We wanted to help investors understand what the
influence [on returns] was from Domini
and what the influence was from Wellington,"
says Laible.
Through the end of September, the MSCI EAFE NR
posted an average annual return of 8.4%
over the previous five years. The Domini benchmark returned an annualized 9.9% during that time
frame, suggesting Domini's impact screening
added 1.5 percentage points per year of return. The
fund itself returned even more, an annualized
10.9% for the investor shares-net of annual
expenses that were as high as 1.6% over that time
period. That demonstrates the significant excess
return added by Wellington.
"We expect Domini will add alpha over the long
term and Wellington will add alpha both in
the short term and in the long term," Laible says.
"The goal is to meet the needs of socially
responsible investors by coupling that positive
social and environmental outcome with competitive financial returns."
Leonard would agree that this goal has been met
for her clients. "The fund's performance has
been good, really good," she notes. "We
constantly monitor all funds in the space. The good
news is the space is growing, but there are still
only a handful of pure, diversified international
funds. The others don't have the same track
record-or as strong a presence in advocacy." K
Tom Lauricella is the editor of Morningstar Direct.

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Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018