Friday, May 11, 2007

Asset Class Reader: Social Responsibility Investing (SRI)

Two recent studies on Social Responsibility Investing (SRI)

Socially Responsible Investments: Methodology, Risk Exposure and Performance

Renneboog, Luc, ter Horst, Jenke R. and Zhang, Chendi, (April 2007)

This paper surveys the literature on socially responsible investments (SRI). Over the past decade, SRI has experienced an explosive growth around the world. Particular to the SRI funds is that both financial goals and social objectives are pursued. While corporate social responsibility (CSR) - defined as good corporate governance, sound environmental standards, and good management towards stakeholder relations - may create value for shareholders, participating in other social and ethical issues is likely to destroy shareholder value. Furthermore, the risk-adjusted returns of SRI funds in the US and UK are not significantly different from those of conventional funds, whereas SRI funds in Continental Europe and Asia-Pacific strongly underperform benchmark portfolios. Finally, the volatility of money-flows is lower in SRI funds than of conventional funds, and SRI investors' decisions to invest in an SRI fund are less affected by management fees than the decisions by conventional fund investors.

The Price of Ethics: Evidence from Socially Responsible Mutual Funds

Renneboog, Luc, ter Horst, Jenke R. and Zhang, Chendi, (April 2007)

This paper estimates the price of ethics by studying the risk-return relation in socially responsible investment (SRI) funds. Consistent with investors paying a price for ethics, SRI funds in many European and Asia-Pacific countries strongly underperform domestic benchmark portfolios by about 5% per annum, although UK and US SRI funds do not significantly underperform their benchmarks. The underperformance of SRI funds does not seem to be driven by the loadings on an ethical risk factor. SRI funds do not suffer a cost of reduced selectivity nor do SRI funds managers time the market. There is mixed evidence of a smart money effect: SRI investors are unable to identify the funds that will outperform in the future, whereas they show some fund-selection ability in identifying ethical funds that will perform poorly. The screening activities of SRI funds have a significant impact on funds' risk adjusted returns and loadings on risk factors: corporate governance and social screens generate better risk-adjusted returns whereas other screens (e.g. environmental ones) yield significantly lower returns.

Additional studies on SRI:

Socially Responsible Indexes: Composition and Performance

Statman, Meir, (January 2005)

One purpose of this study is to explore the characteristics that define socially responsible companies by comparing the content of the S&P 500 Index of conventional companies to the contents of four indexes of socially responsible companies, the Domini 400 Social Index (DS 400 Index), the Calvert Social Index, the Citizens Index, and the U.S. portion of the Dow Jones Sustainability Index. A second purpose of the study is to compare the returns of the four SRI indexes to those of the conventional S&P 500 Index, and to examine the tracking errors of the SRI indexes relative to the S&P 500 Index.

We find that SRI indexes vary in composition and social responsibility scores but the mean social scores of each is higher than that of the S&P 500 Index. Socially responsible indexes differ in the emphasis they place on social characteristics. For example the DS 400 Index is the strongest among all indexes on the environment while the Calvert Index is strongest on corporate governance.

We find that the returns of the DS 400 Index were higher than those of the S&P 500 Index during the overall May 1990 - April 2004 but not in every sub-period. In general, SRI indexes did better than the S&P 500 Index during the boom of the late 1990s but lagged it during the bust of the early 2000s.

The correlations between the returns of SRI indexes and those of the S&P 500 Index are high, ranging from 0.939 of the DJ Sustainability Index during January 1995 - April 2004 to the 0.985 of the DS 400 Index during September 1999 - April 2004. But tracking errors are substantial. For example, the expected difference between 12-month returns of the DS 400 Index and the S&P 500 Index, based on correlation and standard deviations during May 1990 - April 2004, was 2.84% and the realized mean difference was 2.49%.

The Religions of Social Responsibility

Statman, Meir, (July 2005)

Investors who follow different tenets of social responsibility and choose different socially responsible mutual funds can be described as members of different religions. Some social responsibility religions have a single tenet, such as protection of the environment, while other social responsibility religions combine several tenets, such as avoidance of tobacco, alcohol, and weapons.

The framework of the economics of religion can help us answer questions such as:

- Why do some mutual funds attract many investors while others attract few?

- What are the differences between strategies that are effective at attracting individual investors to SRI and those effective at attracting institutional ones?

- How do tenets, such as opposition to tobacco, come to the forefront or recede?

- Are government regulations aimed at fostering SRI likely to accomplish their aim or are they likely to retard SRI? And is the SRI movement likely to grow stronger in the U.S. or in Europe?