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December 27, 1999

IPS Millennium Fund Looks Toward the High Technology Future
    by Phillip Johansson

An interview with Portfolio Manager Robert Loest reveals a mutual fund with personality and futuristic market savvy. -- How do you describe a mutual fund whose portfolio manager compares high-tech companies to Neolithic farmers? IPS Millennium Fund is riding a wave of the future, a future of rapid transition in our Civilization into a higher level of "connectedness," and the surf's up for investors with similar views on civilization, technological innovation, and corporate ecosystems.

SRI Mutual Funds GuideThe IPS Millennium Fund is a no-load, Growth & Income multi-cap fund using a "Barbell" investment strategy: volatile high income stocks, such as emerging telecommunications and internet companies, are balanced by lower volatility, higher dividend companies at the other end of the barbell. This strategy is apparently paying off, with returns as of 12/23/99 at 113 percent, year-to-date, 53.92 percent for three years, and 41.38 percent since inception (1/3/95).

This uncommon fund could only be managed by an uncommon person, one who could discuss digital rights management, Iridium's satellite technology, and risk-adjusted growth prospects in a single breath. That person is Dr. Robert Loest, Senior Portfolio Manager and CEO of IPS Advisory, Inc., in Knoxville, Tennessee. With a Ph.D. in biology, a U.S. Naval career, and a Financial Analyst Charter, Loest brings a unique and worldly perspective to managing the IPS Millennium Fund.

We spoke to Loest about the Millennium Fund's five-year history, philosophy, and distinction from other funds with social and environmental agendas. Along the way, we find much to learn from the originator of Loest's Law #2: "Making mistakes isn't optional. Letting them grow into 900 pound, ring-tailed, slobbering, portfolio manager-gobbling nightmares is."

Social Funds: What ever possessed you to start the IPS Millennium Fund in the first place?

Robert Loest: We've been managing private money at IPS since 1988, with an excellent track record. Many people wanted to invest with us, but didn't have the $250,000 necessary to qualify for a privately managed account. My partner, Greg D'Amico, and I decided that we were turning down too many folks like this, and wanted to offer our unique management philosophy to more people, so we decided to start a fund family that could do so.

SF: What are your most vivid memories around the inception of the fund?

RL: The month before the Millennium Fund started, the stock market took off, the Web was born, and everything we had done, thought and bought (other than our ethical investment approach) up until then became obsolete. During that month of Dec., 1994, we had suddenly and finally left behind the old, wheezing, tired, mature industrial civilization of the past, and entered a new world, just as surely as the invention of the printing press changed everything drastically, immediately, and forever.

We had to tear down our entire intellectual structure on which we had build our investment philosophy, and start over again from scratch. By late Spring, 1995, my models of reality and of how the economy worked and how stocks add value looked like Berlin at the end of WWII. We had to create a new mental model with which to view the economy and the markets. It took us six months of intensive research and reading, but we finally began to reassemble our world view into something that could model and successfully predict what companies would add value to our clients investments.

SF: What is your investment strategy? How does your doctorate degree in biology integrate into your managerial style?

RL: We believe that the economic system is far better modeled using biological concepts like ecosystems, network effects, and Complex Adaptive Systems (CAS) theory, than by using the bankrupt mechanistic model of classically trained economists, and originally derived from Newton. This leads us to use concepts like the learning curve, a biological concept, to select companies. We pick companies in new, "disruptive" technologies that are farthest out on the curve, because without some unusual event, those behind them cannot catch up. CAS tells us to buy those companies that are creating the strongest and most complex ecosystems around their technology or business (Yahoo!, Microsoft, Enron, etc.).

In addition, we have developed from a knowledge of history an approach that recognizes that human civilization develops pretty much like life has evolved on the planet. This is described in both cases by Niles Eldridge and Stephen Jay Gould's evolutionary biological concept of "punctuated equilibrium." Things change very little for very long periods of time. Then occasionally some huge disruptive change throws everything into turmoil in a very brief period of time. Huge numbers of species (companies), genera (related companies) and even families (investment sectors) die out and are replaced by totally new organisms (companies and technologies).

Instances of this in human history are the development of agriculture about 12,000 years ago, the invention of the printing press in the mid-1400s, the perfection of the steam engine by James Watt in 1800, the introduction of the telephone, electric motors and internal combustion engines in the late 1800s, and most recently the development of the Internet and World Wide Web. In every single case, a disruptive new technology has driven down, by orders of magnitude, the cost of some critical limiting resource (food, information, power) that has stranded our civilization on a plateau, and prevented humanity from scaling dramatically new heights and standards of living. In every single case, virtually ALL of the new value that was added, was added by those companies or assets or organizations that directly drove down the cost of the critical limiting resource of the age.

SF: How do you describe Complex Adaptive Systems (CAS) to a construction worker at a cocktail party?

RL: I ask him to think of a honey bee hive. A complex adaptive system is one that has the following characteristics:

1. A large number of nodes, people, insects, computers, whatever;
2. The nodes are all interconnected;
3. The interconnections are broadband and continuous;
4. Feedback among all the nodes is unlimited.

This is a CAS. Once you have one, very strange things begin to happen. One of them is that emergent properties begin to develop. In the case of a honey bee hive, once you have put together a critical mass of honey bees, they stop functioning as solitary insects, and begin to operate as a hive mind, an emergent intelligence. The hive mind possesses totally new qualities not found in smaller amounts in the individual nodes, or bees (or people!).

Our view is that the human race is very rapidly developing all the four characteristics described above, as a result of the Internet and the Web, and that this level of connectivity will soon change us as a species. The companies that are contributing to the development of this connectivity, or that benefit directly from it, is where a hugely disproportionate amount of the new value that is created will be. We look for those companies to buy.

SF: The funds performance is beyond belief. Did you expect this?

RL: I don't have any expectations. We are in the business of using biological concepts as futurists, and applying those to stock selection. It is what it is. We are excited by the innovation in mental models, and a way to apply them. We are basically a think tank. Fund performance is just how we happen to measure the accuracy of our mental models.

SF: How do you distinguish the IPS Millennium Fund from other "social" funds, and why do you prefer to use the adjective, "ethical?"

RL: I view socially responsible investing as a subset of ethical investing. Socially responsible is a good thing to be - don't misunderstand me. I just don't think it's enough. In my view, ethical investing means broadly ethical, not a narrow set of concerns related to some specific area like socially responsible investing. For us, this includes the way companies view animals other than humans, the environment, and the way their management and directors behave toward their stakeholders and the world at large. I don't care how socially responsible other people think company is, if they run their company into the ground and have to fire their employees, like Levi Strauss has done, they are unethical in the larger sense of the term. If they sue someone at the drop of a hat, like McDonald's did the original McDonalds clan in Scotland for using their own name, they are unethical. Ethical covers a lot more territory for me, you see, than the term socially responsible.

SF: Why don't you include social and environmental screens in your prospectus?

RL: We do not screen stocks. I view screening as naive, misleading and simplistic. As a purely ethical matter, we are obligated to our shareholders to earn the best possible return on their money, consistent with our investment philosophy. Philosophy, I might add, subsumes the concept of ethics. We look for companies that satisfy that primary function, then test (not screen) them to see if their management behaves ethically in those areas that matter for a particular company. It's silly, for instance, to worry about Yahoo! testing animals, but not about their corporate behavior toward their community and the world in general. It's legitimate to ask if our electric utility selections are contributing to lowering pollution by increasing the efficiency of generating power and turning toward natural gas and renewable energy sources like geothermal.

We are always open to new information that may cause us to revise our opinion of a company. An example of this is when Intel a couple of years ago set up a foundation to take over sponsorship of the national high school science fairs. They encouraged students to experiment on animals. We wrote the foundation and Intel to request that they change their procedures to discourage students from animal experimentation. They replied that they felt humans had more value than animals, and that any animal that could provide humans a chance to live a better life by its sacrifice was duty bound to die for us. Many SR investors agree with this notion, which I regard as monstrous. We sold Intel.

SF: Do you get involved in shareholder activism as well?

RL: We do talk to management, and try to change their views when we feel it's appropriate. Most of the time, however, we simply sell stocks of companies that do things we don't like. We are too small to have any credibility with companies, and ethical investors of various kinds have at least partly destroyed any credibility we may have had with some very political and dogmatic positions of doubtful value. Mind you, I don't mind blowing up a ship that's killing whales, but that's a pretty black and white issue compared with many. For instance, is providing a job for a mother who can't feed her kids, at what is a good wage in a local SE Asian economy, but at the cost of a job in the U.S., and at a far lower wage than she would earn here, a good or a bad thing? Socially responsible investors tend to be dogmatic about such things, but I'm not convinced it isn't a good thing.

We also vote our proxies, and often depart from management recommendations on issues we feel are important to us, and these generally are what I would regard as socially responsible issues.

SF: What kind of investor would be interested in investing in the IPS Millennium Fund?

RL: Someone who agrees with our broader definition of ethical investing, and believes we are heading for a highly connected civilization.

SF: How about a word, or two, about your new fund, the New Frontier Fund?

RL: The New Frontier Fund holds stocks that are all found in the Millennium Fund. However, it does not have an income objective, and thus holds no dividend paying companies like Millennium does. It is also a non-diversified fund, unlike Millennium. This means I can invest up to half the portfolio in as few as two companies with 25% in each one. It was designed this way to allow me to invest large percentages in just a few companies that were clear leaders in the new economy. I will also hold fewer companies in this fund than Millennium does. Typically around 20. It can also be wildly volatile, since performance depends on about three companies on any one day, and not on the market.

SF: What is the future of ethical investing, and where do IPS Millennium and New Frontier Funds fit into that future?

RL: I'd like to think that as human thinking and morality evolve, and living standards increase around the world, many more people will have the economic luxury of investing ethically. As Confucius said, "One cannot expect hungry people to be good." In a global sense, our ethical obligation here in the U.S., in my view, is to accelerate that jump in living standards as fast as we can. That is the only viable long term solution to increasing the ethical behavior of investors, and of people in general. That means encouraging international free trade and free governments, even if it's at the expense of Third World industrial jobs here in the U.S., which is a goal many socially responsible investors would take issue with. IPS Funds will use whatever small economic clout and credibility we can develop to further that goal.

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