Small may beautiful but building a diversified portfolio with these relative minnows still remains a challenge. This is especially true in the socially responsible investment world where the investment criteria are even more stringent. So far, there are only two fund management groups in Europe who have done this - Kempen Capital Management and Bank Sarasin - although more are likely to come on board as the popularity of SRI continues to gather pace.

 Wouter de Ridder, director of the Orange SeNSe Fund, which is part of the Kempen range, says, "As with any fund, small caps should be part of the portfolio because of the risk/return rewards they bring to a portfolio over the long term. For example, in almost each consecutive period, whether it be one, three, five, 10 or 30 years, small caps have outperformed their large cap peers. We also see our fund as being the gateway to another potential 2,800 European companies."

The Orange SeNSe Fund, which has e70m assets under management, was launched in 2002 by Dutch based Kempen, and SNS Asset Management, a leader in the sustainability analysis of companies. The two groups also joined forces to launch the Kempen SNS Smaller Europe SRI Index. the first to track the performance of SRI smaller companies in Europe. The index, which has 70 companies, represents a subset of SRI companies from the HSBC Smaller European Companies Index. They are both used as benchmarks for the Orange SeNSe Fund. Since its launch, the SeNSe fund has won a coveted five star rating from Morningstar, the US based ratings and provider of investment research firm. In the 12 months ending 30 June 2006, it has turned in an impressive 40.3% return against the HSBC Smaller European Companies Index's 26.7% and rose a stellar 37.4% versus 29.6% for the HSBC index in the three year period ending June 30, 2006.

Of course, the secret of success, as with any small to mid cap mainstream fund, is in the stock selection. This is easier said than done in the smaller end of the spectrum. Information is harder to come by with press releases being issued intermittently. Moreover, due to their relatively low volume turnover on the stock market, many only attract a limited following of analysts. In other words, fund managers have to do their homework.

In the SRI world, the difficulties lie in finding companies with a corporate socially responsible programme. Many do not have the time or resources to develop one, which is where Kempen is willing to step in.

They take a proactive stance which means they not only work with potential candidates to develop a CSR plan but also with the fund's existing SRI compliant companies to ensure they stay on the triple bottom line course. This means paying close attention to environmental and social issues as well as the nitty gritty financials.

Companies are evaluated on the basics - earnings potential, competitive edge and management quality but are then rigorously screened for their socially responsible investing policies and business ethics. For example, social issues would cover rules on child labour and the freedom to unionise while environment includes having adopted International Standard Organisation (ISO) certificates for certain processes and products.

Information is garnered from the firms' replies to a detailed questionnaire that the fund sends out as well as organisations such as London based Ethical Investment Research Services and SNS' own databases.

A company receives a pass mark and is included in the Orange SeNSe Fund if it scores at least 50% for two categories while a provisional status is given if a firm achieves 50% in one category. The company then has one year to graduate to the pass stage.

Kempen will then work hand in hand with management, helping them get their CSR houses in order. De Ridder believes it is their hands on approach that sets them apart from the rest of the SRI managers. "We do not judge companies based solely on our criteria but go one step forward and work closely with managers to improve their sustainability profile. Many of these companies do not have the skills set to implement CSR programmes and our aim is to help them reach a level where they can be included in our fund."

De Ridder cites Royal Wessanen as one example. The Dutch health food group failed to make the grade in 2002 because it did not have a formal code of conduct plus it lacked transparency. Kempen worked with them to develop a company wide code regarding sustainable development and it achieved a pass status within the year.