Analysis of Socially Responsible Investing

Table of Contents

Introduction        1

Hypothesis        2

Related Literature        2

Data Selection        4

Table 1 – Funds Selected        4

Methodology        5

Results        5

Table 2 – Factor Values / Statistical Significance        6

Table 3 – Annualized Alpha        6

Conclusion        9

References        11

Introduction

Socially responsible investing (SRI) is a method of investing based on environmental, social and governance (ESG) criteria in analysis.  These criteria may be positive (include companies that meet certain criteria such as working in renewable energy and/or other support causes important to the investor) or negative (exclude companies that support things the investor does not, such as tobacco, weapon manufacturing or perhaps have activities in conflict areas).

The 2018 Report on Sustainable, Responsible and Impact Investing Trends notes that investors consider (ESG) factors as part of $12 trillion of managed assets, an increase of 38% increase since 2016.  This is a 291% increase since 2010 when $3.07 trillion was invested in SRI funds.  In addition to the growth in assets, investors are considering a wider range of concerns than they were just two year prior.  SRI investing now accounts for one quarter of all professionally managed assets.  This expansion is being driven not only by individual investors, but also by institutions such as pension plans, insurance companies, educational institutions, charitable funds and other nonprofits.

This growth is driven by increased awareness of the impact humans have on the earth and each other.  Individual investors want to actively support activities they believe in, but also actively not support those which they are against.  While some institutional investors may have the same drivers, many are driven by the need to account for the beliefs and desires of their constituents.  Will customers use an insurance company that supports causes they don’t agree with?  Will students apply to a university doing the same thing?  Increasingly, the answer to those questions is no.  This has helped to drive the increase in managed assets.    

Investors choose to invest in socially responsible funds because they believe it is important to support behavior that meets their personal beliefs and they want to feel good about the companies in their portfolio.  That said, they are investors, and want to earn a healthy return on their investment.  This paper will address whether funds based on ESG criteria generate returns that are significantly different from funds not bound by those criteria.  This paper will address whether funds based on ESG criteria generate returns that are significantly different from funds not bound by those criteria.

Hypothesis

The hypothesis being tested is that the results for US SRI funds do differ from the overall market as tracked by the S&P 500, Dow Jones Industrial Average and Russell 1000 indexes.  The null hypothesis is that US SRI funds produce results that do not differ significantly from the market.

Related Literature

The origins of socially responsible investing can be traced back to religious movements in the nineteenth century.  At that time, many groups, often led by Quakers and Catholics, began to actively invest only in firms that conducted themselves “appropriately”.  The movement continued into the twentieth century.  In fact, there is still a Catholic values index.  It wasn’t until the 1980s, however, that the movement really began to gain momentum.  

There has been much written about SRI over the past two decades.  The literature can be broken into two major categories; investor motivations and ESG criteria and performance of SRI funds.  Discussions around the first category serve as a good base for understanding not only the basis of the movement, but also the reasons behind the high growth rate in assets managed over the past decade, while discussions around fund performance provide benchmarks and valuable commentary about SRI returns versus the market.

In 2012, Thomas Berry and Joan Junkus investigated the motivations of investors who were already invested in SRI funds, as well as those who had not yet invested.  They found that despite the growth in SRI, there was not a consensus of what the term meant.  This, in turn led to a lot of subjectivity among investors and potential investors.  Berry & Junkus found that both SRI and non-SRI investors were looking for a more balanced approach to deciding whether a firm meets SRI criteria; looking at a company’s overall profile instead of having firm exclusionary criteria in place.  Berry & Junkus further noted that the “negative screening” used by many SRI mutual funds and indexes is problematic because investors don’t view each part of the criteria the same way.  For example, one investor may be against pornography, but not gun manufacturers, while another may be against tobacco, but not alcoholic beverages.  Investors also don’t believe that products, or companies, are absolutely “bad” or “good”; “corporate behavior is more subtle than that.” (Berry & Junkus, 2012)  They also note that, while it may be easier for a fund manager to use an exclusionary approach, the products or companies most often excluded did not rank at the top of investors’ concerns.  

Kevin Mahn [2016] agrees that there is nothing inherently wrong with exclusionary screening, but, like Berry & Junkus, notes that most investors will be more satisfied with a more holistic approach.  To that end, he outlined an approach for sustainable SRI, ranking companies across fourteen “issue areas” running from auditing and accounting to environmental performance to HR policies, and using the resulting score as one of the criteria for investment.

There have been many studies on the cost of socially responsible investing and the performance of SRI funds versus the broader market.  The majority of these studies found that SRI funds tended to lag non-SRI funds over the periods analyzed.  David Blanchett [2010] notes that a mandate to exclude types of investments (e.g., tobacco companies) limits a manager’s ability to diversify, and should result in lower returns.  His study of performance over the 19 years from 1990-2009 concluded that SRI funds slightly underperformed non-SRI peers on a pure return basis (-17 bps) but slightly outperformed them on a risk-adjusted basis (+1 bps). (Blanchett, 2010)  He noted that while the results were not statistically significant, that they did suggest that investors should be aware of a potential difference in performance between SRI and non-SRI investments.

Qiu, Movassaghi and Bramhandkar [2018] found that SRI funds underperformed conventional funds across both expanding markets and recessions and in both short- and long-term holding periods but noted that performance improved when the number of screening criteria expanded.  They also noted that the gap in returns narrowed as the holding period lengthened.  This led them to the conclusion that “doing good need not come at the expense of doing well.” (Qiu, Movassaghi, & Bramhandkar, 2018)

Data Selection

Nine socially responsible funds were chosen for this analysis.  These funds represent a cross section of funds in the market in terms of total net assets, investment style, ESG criteria and target investor.  Monthly values for Total Net Assets and Return per Share for each fund were downloaded from the CRSP database for the 60-month period from April 2012 – March 2017.  The Fama-French factors for the same period were also downloaded.  The funds chosen are outlined in Table 1 below.  

To compare the performance of the selected funds to the overall market, the monthly returns, along with the equally weighted and value weighted averages, for the S&P 500 for the same 60-month period were used.

Table 1 – Funds Selected

...