Will Arndt

2/27/18

LIFE Portfolio

Socially Responsible Investing

The idea of investing in a company because it is socially responsible has been around

forever. Before investing in companies in the stock market, people did only face to face

deals. In those deals some people judge character over almost all else, you have to be a good

honest person to have people want to invest in your business. That still stands today, only the

corporations are larger and the investments technological. Socially responsible investing is

focusing on a corporation’s environmental, social, and governance policies before looking at

the financials. It stresses the importance of companies who adopt policies that make a

positive difference in the world. The question becomes though, does focusing on social

responsibility sacrifice profits in order to feel good about where your money is invested?

In recent years ESG investing has become much more popular, and there’s a reason,

SRI is a way to help make a difference in the world. Some people think it may sacrifice

profits, but I truly believe that while not increasing profits in any significant way, there is not

enough evidence to prove that SRI’s lower profits. While not necessarily making a larger

profit SRI’s are a legitimate investment strategy that over the long run has shown will profit

the investor. Along with the fact that more companies than ever are focused on pro-ESG

policies and SRI seems like a great investment for the future.
 It was only in 1990 that an index was created to track the performance of 400 socially

responsible companies stocks (RBC, 2). The idea of social responsibility is new but there are

many different ways to track them all. Just as there are different ways to track an SRI

company’s performance, there are different ways to measure how well SRI’s do against the

field. One is measuring the performance of an index like the FTSE KLD 400 which was the

first and one of the most comprehensive SRI indices, against the S&P 500. If we look at the

chart we will see the trend that overall if we look at it the KLD vs. S&P we see that from

1990 to 2012 the KLD slightly outperforms the S&P (RBC, 3). Numbers wise the KLD has

beaten the market by a half a percent a year, but hidden in that profit number is the fact that

the KLD is more risky. Now if we look at other indices compared to the KLD we see that it

really is not much different than most standard indices in that time period. Yes there may be

some evidence that they do better when looking at charts like these but they don’t take into

account everything that’s going on within these companies.

The differences shown in index measurements could be chalked up a number of

different things, industry health, size of the index, types of investments. To gain more insight

into these trends we can look at a smaller sample size, like mutual funds. When looking at

mutual funds we see that overall the results are pretty all over the place. At times we see that

SRI funds perform pretty close to the average traditional fund with some performing better

and others performing worse (RBC, 4). Though research has been done that shows funds that

use specific screens can maximize their alphas with the best of the best having alphas of

around 8.7% (Kempf, 16). So with these pieces of evidence we can see that we really have
no agreed upon evidence that shows a SRI fund is any better than normal but also being

pretty sure that the SRI puts no burden on an investors profits.

Now the one problem we run into when comparing these mutual funds is that SRI

mutual funds are relatively new and the historical data just isn’t there, most of the time we

can’t do even a ten year performance review. All these add up to the fact that with what we

have, we have no proof that SRI mutual funds do any worse or better than normal funds.

When examining the funds and indices, there was one apparent factor that we do need to

look at the risk, which is the risk involved in SRI and whether it is more or less risky than

investing with no screen.

Risk associated with investing responsibly comes in different forms and some are

negative, some positive. One risk associated with socially responsible investing is

diversification risk, based on modern portfolio theory. The basic idea is that a portfolio with

more diversification will be able to get rid of as much of their unsystematic risk as possible,

so someone who is investing with screens will have less diversification and more risk. If you

have less companies to choose from and less industries, your unsystematic risk goes up

which can hurt your profits (Stanley, Herb). You also tend to be risking money investing in

companies who use funds for ESG programs instead of focusing on turning their money into

profits. While these two idea can be risky to a portfolio you can also mitigate risk by

investing in SRI’s. Companies in an SRI portfolio usually are better companies in terms of

growth and core values, which may not directly lead to company performance but it

definitely doesn’t hurt. It also helps that people who are screening companies usually have to

do a lot of research on the company to make sure that the company meets their SRI screens.
This means that any inherent problems with the company are detected and avoided, leading

to a portfolio with safer, less volatile positions. Also, companies who pass the social screens

usually do better for all their stakeholders, employees, suppliers, investors, all love to see

social responsibility because it is usually an indication of sustainability.

With this idea we can look at one piece of research done to show the effectiveness of

the screens. A paper written by Michael Barnett and Robert Saloman has shown that the

relationship between a screen’s intensity and if the fund performs well financially. Their

study shows that the graph has a u-shape, meaning that as the number of screens climbs, at

first profits drop, but as you use more screens the profits start to climb again (Stanley, Herb).

This trend shows that if you use just a few screens your heightened risk is not covered by the

idea you’re only picking good companies, but as you add more screens your risk is mitigated

by the fact you are most likely picking good, long term value companies and your profits will

end up being the same or a percentage or two better than a normal index. Using screens does

not add up to less profits but there is no reason to believe a screen will end up increasing

profits (Stanley, Herb).

With the idea that profits neither increase nor decrease when choosing companies

based on their social responsibility, we can talk about if they are a good investment idea or

not. In my opinion and looking at all the research, I have come to the conclusion that SRI is a

legitimate investing idea and people who invest this way will see profits similar to the

benchmark, and might beat the market by a percent or two all else equal. All in all investing

in socially responsible companies is a great idea, you won’t lose any profits in the short term

and the companies invested in will most likely have a solid long term strategy. Along with
these long term strategies, these companies can sometimes be considered undervalued

because normal investors may tend to stay away from these funds/companies. With this

investing also come the fact you will feel better about yourself when you invest this way

because you are only putting your money into companies that do good. These companies are

trying to make a difference in the world and you are supporting that idea, there’s no better

feeling than that. You won’t have to worry about losing profits and you’ll feel good about

your investments morally, there is really no better alternative than socially responsible

investing if you’d like to hold to your morals and make money.

 Bryan, CFA Alex. “The Benefits and Costs of Socially Responsible Investing.” Morningstar.com,

www.morningstar.com/articles/679225/the-benefits-and-costs-of-socially-responsible-inv.html.

Corporate Author. “Does Socially Responsible Investing Hurt Investment Returns?” RBC-GAM,

Sept. 2012, funds.rbcgam.com/_assets-custom/pdf/RBC-GAM-does-SRI-hurt-investment-returns.pdf.

Derwall, Jeroen, et al. “A Tale of Values-Driven and Profit-Seeking Social Investors.” SSRN

Electronic Journal, 13 July 2010, doi:10.2139/ssrn.1641131.

Kempf, Alexander, and Peer Osthoff. “The Effect of Socially Responsible Investing on Portfolio

Performance.” CFR Working Paper, May 2007,

www.econstor.eu/bitstream/10419/57725/1/702962686.pdf.

MoneyShow. “Socially-Responsible Investing: Earn Better Returns From Good

Companies.” Forbes, Forbes Magazine, 16 Aug. 2017,

www.forbes.com/sites/moneyshow/2017/08/16/socially-responsible-investing-earn-better-returns-

from-good-companies/#12f5f35c623d

Stanley, Darrel J., and Christopher R. Herb. “The Moral and Financial Conflict of Socially

Responsible Investing.” Gradziadio Business Review, vol. 10, no. 1, 2007,

gbr.pepperdine.edu/2010/08/the-moral-and-financial-conflict-of-socially-responsible-investing/.

Tran, Thuy. “Corporate Social Responsibility and Profits: A Tradeoff or a Balance?” Stanford

CDDRL, May 2015, cddrl.fsi.stanford.edu/sites/default/files/thuy_tran_cddrl_thesis_v3.pdf..