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Presentation for Dissertation Proposal Defense

  1. 1. The Effect of the Business Cycle on the PERFormance OF SOCIALLY RESPONSIBLE INVESTMENTS<br />Dissertation Proposal Defense<br />Andrea Roofe<br />May 5, 2010<br />
  2. 2. What is ‘Socially Responsible Investing’?<br />Socially responsible investing (SRI) “…integrates environmental, social and governance factors into investment decisions" <br />(Social Investment Forum, 2010a)<br /><br />
  3. 3. Outline of the presentation<br />Background<br />Research Questions and relevance of the study<br />Theoretical perspectives<br />Methods<br />Preliminary findings<br />
  4. 4. BACKGROUND<br />
  5. 5. SRI movement: Historical Background<br />need to express personal value system through investing:religious and secular values.<br />slave trade and war (17th - 19th century)<br />alcohol, tobacco, firearms and gambling activities (1920s)<br />civil rights, the Vietnam War, apartheid, and consumer issues (1960s-80s)<br />corporate governance and sustainability issues (1990s and early 21st century)<br />
  7. 7. Research Questions<br />Does socially responsible investing deliver financial value? <br />Does the SP-FP relationship vary across phases of the business cycle?<br />To what extent are net excess returns attributable to fund-SRI index differences, and index-benchmark differences?<br />What is the nature of the FP-SP link on religious and vice funds? How do they compare to secular SRI funds and conventional funds?<br />
  8. 8. Relevance of the study<br />Public concern with issues in corporate governance (ENRON, 2008 crisis in the financial markets).<br />Size of SRI market: <br />70 inst investors representing US$4 trillion.<br />260 mutual funds (AUM>$200b) in 2007.<br />55 funds (AUM~$12 billion) in 1995.<br />Paucity of research into the performance of SRI equity mutual funds during a severe economic downturn.<br />Performance of SRI mutual funds (AMANA Growth Fund , Ave Maria Catholic Values Growth Fund, Calvert Long term Income Fund A-Lipper ratings 2009 and 2010)<br />
  9. 9. Theoretical Perspectives<br />
  10. 10. Review of the literature<br />Stakeholder Theory and CSR-the basis for SRI <br />The social performance-financial performance (SP-FP) connection <br />The SRI Investment Process <br />Business Cycles and SRI <br />Recent trends in SRI<br />
  11. 11. Definitions<br />Social performance-rating assigned to a company based on investor perception of a company’s social responsibility.<br />Financial performance-the long-term profitability of the corporation or the excess returns delivered by the SRI fund. <br />SP-FP link takes place at 2 levels:<br />CSR->FP by the firm<br />CSR-> high SP rating -> SRI investment <br />
  12. 12. -Stakeholder theory-the rationale and foundation of SP<br />Stakeholders include all entities in the society whose interests or welfare are affected by the company’s actions (Freeman, 1984)<br />Stakeholder interest is financial only (Friedman, 1970)<br />Hybrid approach-corporations attempt to achieve long term profit maximization by engaging with diverse entities to minimize conflict and maintain long term competitiveness ”enlightened self-interest” (Porter, 2006; Jensen, 2001)<br />
  13. 13. SRI and the parallel SP and FP link<br />SP-FP (corporate): SP-> FP through competitive advantage<br />SRI (investor): financial returns and utility (satisfaction) of social investing<br />
  14. 14. SRI investor attitude toward risk<br />Adaptation of Tobin’s Liquidity Preference Theory as behavior toward risk (1958).<br />Risk lover-gives up financial returns in exchange for more risk.<br />Risk averter (diversifier)–balances risk, return-at higher levels of risk, more returns needed in exchange for the same amount of risk<br />Risk averter (plunger)-higher returns in exchange for more risk-accepts more risk in exchange for the same amount of return.<br />
  15. 15. Social Criteria Preference as Behavior toward Risk<br />SRI investor tradeoff among risk-return-social performance (Beal et al., 2005; M. Moskowitz, 1972; M. Moskowitz, 1997). <br />Ethical financial-investor is risk averse on both financial and social criteria.<br />Ethical consumer-investor and investment-investor either risk averse (plunger) or a risk lover on the social performance criteria. May be risk averse on financial criteria.<br />
  16. 16. Relevance of the Social Criteria construct<br />This attempt to define a new construct in the SRI-financial literature should help in defining the implications of behaviors identified by the hypotheses.<br />In spite of the focus on financial returns, SRI is a behavioral phenomenon.<br />
  17. 17. SP-FP link and the business cycle<br />
  18. 18. SP-FP theoretical perspectives<br />Linked to perspectives on stakeholder theory:<br />Companies engaged in social performance deliver superior financial performance.<br />The benefits of SRI outweigh the cost of screening the investment.<br />SRI is consistent with Prudent Investor Rule (fiduciary duty to consider well being of the trust)<br />
  19. 19. SP-FP theoretical perspectives<br /><ul><li>Social performance has an adverse effect on financial performance-inefficient use of resources.
  20. 20. SRI limits the trustee’s universe of stocks (financial stakeholder view-Prudent Man considers financial returns)
  21. 21. Added cost of SRI screening detracts from the excess return on the fund. </li></li></ul><li>Vice vs. Religious vs. Traditional SRI<br />Vice funds <br />Recession resistant ? Less risky? More consistent returns?<br />More risky? Higher returns?<br />Religious funds <br />a smaller universe of stocks-more risky?<br />Stock portfolio subject to less industry risk-more consistent returns?<br />
  22. 22. SP-FP empirical findings<br />Mixed mostly positive empirical results of relationship between SP and FP<br />Some neutral or inconclusive<br /> (UNPRI, 2007; Orlitzky, Schmidt &Rynes, 2003; Margolis and Walsh, 2001).<br />
  23. 23. Business Cycles and SRI<br />Weak economy – risk of loss-high expected return (Fama & French, 1989)<br />Fund manager skill required (Siegel, 2009a)<br />Strong economy – less risk of loss-lower expected return.<br />Does the inclusion of SRI screens add value to the investment process?<br />Do religious or vice funds perform better during good/bad times?<br />
  24. 24. Trends in SRI<br />Specialized funds-environmental, religious, vice, international, country /regional-there is a fund for every need!<br />UNPRI –SRI acceptance by financial community.<br />B Lab/B Corporation certification-development of formal standards and audit procedures for SP.<br />SEC addition of climate risk to list of disclosures.<br />
  25. 25. METHOD<br />
  26. 26. Method<br />Hypotheses<br />Measures <br />Proposed Sample <br />Approach<br />
  27. 27. Hypotheses<br />Hypothesis 1(a) There is no difference between the performance of SRI indices and their conventional benchmarks during periods of economic expansion.<br />Hypothesis 1(b) There is no difference between the performance of SRI indices and their conventional benchmarks during periods of economic contraction. <br />
  28. 28. Hypotheses continued<br />Hypothesis 2 SRI delivers positive net excess returns (after expenses). <br />Hypothesis 3a Religious funds have greater excess returns than vice funds, and their conventional benchmarks. <br />Hypothesis 3b The Vice Fund delivers greater excess returns than traditional SRI funds, and religious funds.<br />
  29. 29. US Business cycles 1991-2008<br />
  30. 30. The model<br />Fama-French model<br />Excess returns= a + beta*(rm-rf) + c*SMB + h*HML <br />SMB stands for "small (market capitalization) minus big" and HML for "high (book-to-price ratio) minus low"; they measure the historic excess returns of small caps over big caps and of value stocks over growth stocks. SMB, HML (Fama-French Web site), rm, benchmark index rf= 30 day Treasury bill rate<br />Carhart 4 factor model<br />Excess returns= a + beta*(rm-rf) + c*SMB + h*HML + j*MOM<br />MOM "Momentum" is the empirically observed tendency for rising asset prices to raise further. Momentum leads to price bubbles.<br />
  31. 31. Markov switching regime (2 states)<br />Each observation is weighted by the probability that it occurred during a period of expansion or contraction-Markov 2 state regime switching model<br />Probabilities are based on the value of R1Y1 (dividend yield-current source of information)<br />Excess returns= Si*alpha + Sibeta*(rm-rf) + sic*SMB + sih*HML + sij*MOM + sip*R1Y1 <br />0≤ p(s) ≤1 <br />s = 1, recession or 2, expansion <br />
  32. 32. RQ 1-Sample<br />
  33. 33. Method-RQ1<br />Compares historic difference between SRI index returns and that of the conventional benchmark.<br />Compares risk adjusted difference between SRI fund returns and total returns on related SRI indexes.<br />Fama-French 3 factor model<br />Carhart 4 factor model<br />
  34. 34. Analysis-RQ1 and RQ3 <br />1. Compare at each of the phases of the business cycle of 1991-2008 the excess returns (Markov 2 state switching regime) apply to Fama-French and Carhart models.<br />2. Compare historical data:<br />correlation coefficient/R-square<br />standard deviation (volatility)<br />Sharpe Ratio <br />Value at Risk (VaR) <br />
  35. 35. RQ 2 sample<br />
  36. 36. Data-RQ2<br />Return on SRI fund<br />Return on SRI index<br />Return on benchmark<br />Expenses (0.75 % to 1.18%)<br />Turnover (an indicator of trading expenses)<br />
  37. 37. RQ 3 sample<br />
  38. 38. RQ 3 sample continued<br />
  39. 39. Preliminary observationsHypothesis 1<br />
  40. 40. RQ1-Preliminary Observations<br />S&P 500 and a unit weighted portfolio of SRI funds<br />
  41. 41. S&P500 index returns-coincident index and KLD Social Equity Index excess returns (1991-2008)<br />
  42. 42. RQ3-Historical Returns<br />S&P 500 and the Vice Fund<br />
  43. 43. THE END<br />