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March 13, 2009
Can SRI Ratings Predict
Stock & Portfolio Performance?
by Ron Robins*
SRI (socially responsible investing) ratings’ firms,
like everyone else, are always looking for the ‘Holy
Grail’ in finding the winning ratings methodology that
can predict the market performance of a stock or
portfolio. At this juncture, no magic methodology has
been found—at least that is public knowledge!
We do know that some SRI stock portfolios have
outperformed conventional compositions, and that these
findings are generally gained through hindsight.
Sometimes they are also ‘back-tested,’ which means they
take the present portfolio and determine how it would
have fared had it existed in years past. But our
question is, are there predictive methodologies
available anywhere that come even close to foretelling
an individuals stock’s, or portfolio’s, future stock
market performance?
The following research from Canada provides some insight
into one ‘possible’ predictive methodology for
portfolios. Titled,
The Impact of Ethical Rating on Canadian Security
Performance: Portfolio Management and Corporate
Governance Implications, by Klaus P. Fischer and
Nabil Khoury (both of the University of Quebec), found
that “… a portfolio of stocks with zero concerns
[‘concerns’ defined by a ratings agency] outperforms
portfolios comprising securities with one, two and three
or more concerns… our research indicates that there is
good reason for relying on the number of concern scores
in screening securities for portfolio composition.”
So here we have validation that SRI ratings can predict
stock market behaviour when applied to stock portfolios
with a differing number of ‘concerns’.
In,
The wages of social responsibility, Meir Statman
(Santa Clara University) and Denys Glushkov (Barclays
Global Advisors) demonstrate that SRI screening provides
superior returns to conventional investing—but with a
proviso. Quoting from their study abstract, “We
analyze returns during 1992-2007 of stocks rated on
social responsibility by KLD and find that this tilt
gave socially responsible investors a return advantage
relative to conventional investors… ”
Continuing, “However, typical socially responsible
investors also shun stocks of companies associated with
tobacco, alcohol, gambling, firearms, military, and
nuclear operations. We find that such shunning brought
to socially responsible investors a return disadvantage
relative to conventional investors. The return advantage
of tilts toward stocks of companies with high social
responsibility scores is largely offset by the return
disadvantage that comes from the exclusion of stocks of
‘shunned’ companies. The return of the DS 400 Index of
socially responsible companies was approximately equal
to the return of the S&P 500 Index of conventional
companies.”
Perhaps the most authoritative compilation of SRI/ESG
(environmental, social and governance) research and its
relationship to market performance was released in an
October 2007 study,
Demystifying Responsible Investment Performance
under the aegis of the United Nations Environmental
Program (UNEP) Finance Initiative. The reviewers overall
conclusion: “Of the twenty studies reviewed, ten
showed evidence of a positive relationship between ESG
factors and portfolio performance, seven reported a
neutral effect and three a negative association.”
These studies reviewed by UNEP show
definite promise for SRI/ESG screening. But what is
observed are performance relationships comparing
portfolios employing SRI/ESG screening with those that
do not. Thus, these studies do not answer our question
of whether SRI ratings, whether applied to an individual
company or to whole portfolios, have any predictive
potential related to stock market outcomes. As
statisticians say, ‘correlations do not prove
causation.’
In summary, SRI ratings applied to stock portfolios
foretelling their future collective stock market
behaviour has shown some potential. However, the
academic work of determining the effectiveness of an
assigned ratings firms’ individual company rating to
stock market outcomes has yet to be done. Complicating
this issue is over what stretch of time does this
tracking need to go on for? Should it be for five, ten
or thirty years? Also, would the ratings methodology
need to change over time? What may hold more promise is
the ‘best of sector’ approach, where a particular
company is deemed a higher ratings’ score than
comparable companies in the same industry.
Generally, we are unlikely to ever find the ‘Holy Grail’
of a highly predictive ratings’ methodology. But whoever
can find something even 60-80% successful over a
longer-term will greatly brighten our world and likely
put Warren Buffett’s investing success to shame! *
Ron Robins, MBA, is founder, Investing for the
Soul (http://investingforthesoul.com/),
Huntsville, Ontario, Canada. He advocates, teaches, and writes
on the subject of ethical investing. To contact him,
e-mail
to Ron Robins or call 705-635-3034.
© Ron
Robins, 2009. |
