July 19, 2010Can Ethical
Investing Produce Higher Returns?
By
Ron Robins, Founder & Analyst - Investing for the
Soul
Yes, it is possible that ethical investing can produce
higher returns. For instance, America’s Social
Investment Forum found in a “ …review of 160 [U.S.]
socially responsible mutual funds from 22 members of the
Social Investment Forum (SIF)… that the vast majority of
the funds—55 per cent—outperformed their benchmarks in
calendar year 2009, most by significant margins… ”
In fact, most studies of ethical and socially
responsible (SR) investing do find roughly similar or
even sometimes higher returns when compared to
conventional investing. And this is what reviewers
concluded after examining thirty key academic and broker
studies related to ethical/SR investing for the United
Nations Environmental Programme (UNEP) Finance
Initiative and Mercer in late 2007.
Based on such evidence, and particularly the results
found and lessons learned from some new studies, I
believe that in the future and over the longer term
ethical/SR investments will generally produce higher
returns than conventional portfolios. Furthermore,
ethical/SR investments have another benefit: they are
more likely to enrich the quality of our lives and for
society as a whole.
Of all the studies on ethical/SR investing in recent
years, perhaps the best credentialed is “The wages of
social responsibility,” by Meir Statman and Denys
Glushkov, published in America’s Financial Analysts
Journal in July/August 2009. It was also the 2008 winner
of the world’s most important SRI prize, the Moskowitz
Prize for Socially Responsible Investing given by the
University of California’s Haas School of Business. The
study found that the so-called ‘best-in-class’
ethical/SR investing approach yielded superior returns.
Quoting from the study, “[that] analyzing 1992–2007
returns of stocks rated on social responsibility...
found that this tilt gave such investors an advantage
over conventional investors. [But] the advantage from
tilting toward stocks of companies with high social
responsibility scores is largely offset by the
disadvantage from the exclusion of stocks of shunned
companies…. “
Continuing, “[and, therefore,] socially responsible
investors can thus do both well and good by adopting the
best-in-class method in constructing their portfolios:
tilting toward stocks of companies with high scores on
social responsibility characteristics but refraining
from shunning stocks of any company.”
This latter point is controversial among ethical/SR
investors. It suggests investing in ‘best-in-class”
companies no matter what industry they may be in. This
means say, investing in defence companies with ‘stellar’
ethical/SR corporate attributes—if there are such
companies—despite the company’s products not aligning
with the investor’s values.
However, I suspect that with investors and governments
increasingly demanding that companies report and improve
upon their environmental, social, and governance (ESG)
activities, in the future there will be fewer companies
engaged in potentially damaging ESG activities. And
therefore there will be a smaller number of industries
and companies for ethical/SR investors to shun. Perhaps
this sounds utopian—but these are indeed the trends. (See
my column.)
The wake-up call of the BP oil disaster also adds fuel
to the promulgation of ESG policies. Some alert
ethical/SR fund managers, having studied and critiqued
BP’s ESG activities, sold their BP stock prior to its
oil spill.
Looking over the past decade it is my observation that
ethical/SR investing returns often have greater
volatility. They frequently surpass conventional fund
returns when the markets do well, but may do worse
overall when the markets go down. This has to do with
their portfolio composition. They commonly overweight
their portfolios with financial, technology and
alternative energy companies—sectors that in the past
decade have usually lead the markets higher—and lower.
But the volatility of ethical/SR funds may change as
investors and fund managers apply the findings of ESG
researchers. One important study released in May found
that, “… [ESG] improves portfolio diversification
through a reduction of the average stock’s specific
risk. …ESG criteria probably leads best-in-class ESG
screened funds to be better diversified than otherwise
identical conventional funds.” Lower individual stock
risk and greater diversification implies lower
volatility. (See “Portfolio Diversification and
Environmental, Social or Governance Criteria: Must
Responsible Investments Really Be Poorly Diversified?”
by Andreas G. F. Hoepner of the University of St.
Andrews, School of Management, Principles for
Responsible Investment, United Nations.)
Incidentally, for links to the most referenced
ethical/SR investing research studies go to
this page on
my site.
One point that troubles most conventional investors
concerning ethical/SR investing is the placing of
personal values above profit—as seen in just released
survey results from the Desjardins Group of Quebec,
Canada. “… [given] the choice between a conventional
fund and an SRI [socially responsible investing] fund
with a 1 per cent lower return, 85 per cent of investors
would choose the SRI fund. Even if the return was 3 per
cent lower, 58 per cent of investors would still choose
SRI funds!” But as the above research proclaims, giving
priority to personal values can be positive for
investing returns.
As investors realize that they can apply their
ethical/SR values to investing and make similar or
potentially better returns compared to conventional
portfolios, investors everywhere will eventually favour
ethical/SR oriented funds and investments. And the added
benefit will be a better world for us all.
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