Dec. 09, 2009
In Copenhagen politicians are gathering on a mammoth conference to discuss climate change and its implications for humanity. This is only one sign that the environment and the responsible use of resources have become a major global topic. But it is not only politicians who think about responsibility.
Wealthy investors have been pouring money into socially responsible investments (SRI) in unprecedented amounts. As the Social Investment Forum states, “Over the past 20 years, the total dollars invested in SRI has grown exponentially, as has the number of institutional, professional, and individual investors involved in the field. Between 1995 and 2007, total dollars under professional management in SRI grew from USD 639 billion to USD 2.71 trillion, outpacing the overall market.”
Broadly speaking, SRI use one of two screening processes — or a combination of the two — to select companies. A "negative screen" filters out whole market sectors widely held to be unethical, including gambling, tobacco, alcohol, armaments, uranium mining and even genetic engineering. Some use a "positive screen", investing in sectors and companies considered to be making a positive contribution to social wellbeing or environmental sustainability.
Some wealth managers have developed a special competence in offering such investment vehicles to their clients. Yet investors are wondering whether “doing good” and “making money” are contradictions or whether or not the performance of SRIs is comparable to the performance of the overall market, potentially even outperforming the market.
Overall, research suggests that SRIs are not or only slightly underperforming their conventional peer groups. Michael Schröder from the German economic research institute ZEW comes to the conclusion that “socially screened assets have no clear disadvantage concerning their performance compared to conventional assets.” Schröder has looked at German, Swiss and US-funds following a SRI-approach.
Luc Renneboog, a professor of corporate finance at Tilburg University, the Netherlands, comes to a similar but somewhat more negative conclusion:
“When comparing the alphas of the SRI funds with those of matched conventional funds, the SRI returns are lower than those of conventional funds, but there is little statistically significant evidence that SRI funds underperform their conventional counterparts in most countries (exceptions being France, Ireland, Sweden, and Japan).”
To complete the scientific survey, Greig Ley of De Montfort University (Leicester), comes to the result that, “As a group, SRI funds deliver risk-adjusted mean financial returns similar to non-SRI funds but the volatility is greater for more recently launched SRI funds, a possible learning effect.”
In fact, as almost every research on SRIs concludes, the performance of the funds is not the problem but risk or volatility seem to be significantly higher. This can be explained by the higher portion of small- and mid-caps (smaller and medium enterprises) which on average are riskier assets. SRI-funds often consist of a very skewed sample of stocks, since the strict screening policies of a fund shrink the universe of investable stocks. Such very narrow investment universes might be much riskier than the broader market indices in particular because they might depend on government subsidies or state regulation which are not very well predictable.
In addition, investor sentiment driven by moral standards might lead to overinvesting in these assets creating a bubble that can implode and hurt performance drastically. As one example serves the German solar industry. Heavy government subsidies and positive investment sentiment have driven the performance of this sector to unsustainable highs. As the government is considering to cut some of the subsidies, stocks of solar equipment manufacturers like Solarworld have suffered heavily.
There can be only one good piece of advice to the investor who wants both, to do good and do well: he should have a critical look on all potential investments, evaluating not only past performance but looking for the hidden risks in stock selection and industry bias. A broad portfolio of different SRI industries is probably much more diversified and therefore less risky than focused and specialized funds targeting overly narrow market segments like for instance pure green energy funds.