Doing well-while-doing-good


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Doing well-while-doing-good

  1. 1. Sally Hamilton, Hoje Jo and Meir Statman "Socially responsible" investors favor certain companies over others according to criteria such as production of weapons or use of alteTnLltive energy sources. We find that socially responsible mutual funds do not earn statistically significant excess returns and that the performance of such mutual funds is n.:Jt statistically different from the performance of conventional mutual funds.I nvestment managers that consider social responsibility minorities and the increase of worker ownership in criteria in selecting securities for their portfolios have corporate America. Second, recognizing the humanreceived much attention from the financial press and price that has been paid in the workplace for muchconsiderable money from investors. The Social Inve~;t- industrial development, SRI promotes practices toment Forum reported that the value of "socially respon- humanize the work environment. These includesible" investment portfolios had reached $600 billion as alternatives to the traditional assembly line and theof January 1992. The TIAA-CREF Social Choice Accounlt, promotion of a clean, safe, and rewarding workestablished in March 1990, had reached $273 million ;IS environment. These two goals must be achievedof September 1992. within the context of making a profit. However, The definition of "socially responsible" companies profit may be misused for unsafe and exploitivevaries greatly. Socially responsible investors typically purposes, and ironically, this can have a serious anduse a combination of "positive" and "negative" invest- negative economic impact. Therefore, a third goal ofment criteria. The Calvert Social Investment Fund, for SRI involves rethinking the ways profit has beenexample, does not invest in companies that have oper- traditionally used and distributed. Finally, all theseations in South Africa, that manufacture weapons, or goals are related to a fourth goal: convincing the that are engaged in nuclear power. The fund favors business world that a corporate conscience cancompanies that are environmentally sound, have good pay. Iemployee relations, good records for advancing minor- Others, such as Rudd, question the legitimacy ofities and good pollution-control management. The New social responsibility criteria:Alternatives Fund favors companies that are environ- mentally sound, those that are engaged in work on There is one important difference between socialalternative energy sources, and those that are devoted to responsibility criteria and others. The latter areresource recovery. Table 1 presents some additional imposed on the manager solely by the investmentexamples. considerations. It is true that they may be mis- There is no general agreement on the role of social guided, but the underlying rationale is defensible;responsibility criteria in investment management. namely, the aim is to protect the financial conditionLowry, a promoter of social responsibility, identified of the beneficiaries. Few of the social responsibility criteria have this property. 2four goals of socially responsible investing (SRI): First, SRI involves strategies to democratize the The criteria for inclusion in a socially responsible economy in two important ways: encouragement of fund create conflict on occasion. For example, a Wall the hiring, retention, and promotion of women and Street Journal article reported that: The Calvert fund --.has been debating whether to sell its 75,000 shares of Angelica Corp, a St. Louis-Sally Hamilton is with the Co~te Financial Planning and Analysi:;Group of Tandem Computers Incorporated. Hoje Jo is an Assistant based hospital-supply company. Last year AngelicaProfessor of Finance at Santa Clanz University. Meir Statman i:; ran afoul of the National Labor Relations Board, andProfessor of Finance at Santa Clara Uni~ity. last month a federal appeals court upheld an NLRB FInarriaI AnaIysts.k>umaJ NoverTre-DecemOOr I 199362
  2. 2. T~ 1. ~ Criteriafa" Irx:Iusic(1 Exck.Jsioo COfT1D1ies ~ or of fa" Socially Respa1siE MutlJalFurxis MutuaIFund Criteria for Inclusion Criteria for Exclusion Calvert-ArielAppreciation E,PC S,W,N } Calvert SocialInvestmentFunds E, ER, PS,PC S,W,N Domini SocialIndex Trust E,C,ER 5, W, N, A&:T, G DreyfusThird CentUIy E, 0, EEO, PS 5, A&:T New Alternatives E,A,R S,W,N Pamassus Fund E, ER 5, W, N, A&:T Pax World Fund A, PS,PC S,W,N,A&:T,G SchieldProgressiveEnvironmentalFund E,A, PC EPA Critem for Inclusion E = environmentallysound C = hassecuremarket segments strOI1g and reputationswith customers, competitorsand employees PS = producessafe products ER = has good employee relations P = producesproducts of good quality 0 = has a good record in equalemploymentopportunity EEO = has a good record in employmentopportunity A = usesalternative energy sources R = recoversreso~ CP = has significant participationin the (:ommunity PC = contributesto the control of pollution Criteria for Exclusion S = has operationsin SouthAfrica W = producesweapons N = uses nuclear power A& T = is part of the alcohol or tobaccoirldustries G = is part of the gambling industry EPA = is a violator of EPA regulations Source: Social Investment Services, January 1, 1992. ruling that Angelicahad wrongly refusedto bargain ond, what are the actual relative returns of socially with a union. responsible mutual funds and conventional mutual Calverts trustees have delayed a decision on funds? whether to dump the stock pending the outcomeof labor talks that Angelica began last week under HYPOlHESES court order. The companyhad a history of reason- There are three alternative hypotheses about the relative ably good labor relationships,so weve beengiving returns of socially responsible portfolios and conven- them the benefit of the doubt," says Lawr,ence tional portfolios. The first hypothesis is that the (risk- Litvak, a U.S. Trust portfolio manager. Angelica adjusted) expected returns of socially responsible port- says it is "hopeful" it can reach a "satisfa<:tory folios are equal to the (risk-adjusted) expected returns of agreement" with its union. conventional portfolios. This is consistent with a world But nonsocial considerations will also influ,ence where the social responsibility feature of stocks is not the decision to sell or keep the stock. Mr. Litvak priced. In other words, socially responsible investors says the union problem partly reflects Angelicas who sell stocks find enough conventional investors responseto increasedcompetition in the hospital- ready to buy that the prices of the stocks do not drop. supply business.The competitive squeeze profit on This is the hypOthesis that is closest in spirit to the margins also gives Mr. Litvak concern about the standard framework of finance, where factors that are value of Angelicas stock, he saYS.3 not proxies for risk do not affect expected returns. Becauseexpected returns to investors are also the cost of We do not join the debate about the legitimacyof capital to the company, this hypothesis implies thatsociallyresponsibleinvesting or the relativemerits of the socially responsible investors do not reduce the relativevaried and conflicting criteria. We take the definitiol1Sof cost of capital to socially responsible companies by favoring their stocks. social responsibility from their promotersand ask twoquestions. First, what are the alternative hypotheses The second hypothesis is that the expected returnsabout the expectedrelative returns of sociallyresponsi- of socially responsible portfolios are lower than theble mutual funds and conventional mutual funds? Sec- expected returns of conventional portfolios. This hy-RnarK:iaf Analysts Journal! November-~r 1993 63
  3. 3. pothesis implies that socially responsible investors tlave outperfonned the NYSE portfolio by 0.187% per yearan impact on stock prices. In particular, they increase over the 1960-83 period. Grossmanand Sharpe alsothe value of socially responsible companies relativ,~ to found that the outperformance of the South Africa-freethe value of conventional companies by driving down portfolio can be attributed entirely to the fact thatthe expected returns and the cost of capital of socially companies that portfolio are smaller,on average,than inresponsible companies. This also implies, contrary to the the NYSE companies.7first hypothesis, that the market prices the social respoOn- The studies by Rudd and Grossmanand Sharpesibility characteristic. comparethe perfonnance of stocks of South Africa-free The plan by RJR Nabisco Holding Inc., which sells companies with the perfomlance of index portfolios.both tobacco and food, to issue a class of stock pegged to Their analysesleave open two questions. First, socialits food business alone illustrates the point. According to responsibility criteria include issuesbeyond South Af-Shapiro, RJR Nabisco managers believe that the com- rica; what about the perfomlances of portfolios thatpanys market value is depressed in part because some embrace other social responsibility criteria? Second,investors avoid tobacco stocks for moral reasons; ciga- most investorschooseactiveportfolios rather than indexrettes are linked to the deaths of 434,000 Americms funds; how do socially responsible portfolios perfOmlevery year.4 relative to active conventionalportfolios? The third and last hypothesis is that the expectedreturns of stocks of socially responsible portfolios ,are EMPIRK:AlANALYSIShigher than the expected returns of conventional p<Irt- Lipper Analytical Servicesprovided us with monthlyfolios. This is the case of "doing well while doing goo<i." returns (including dividends) of all equity mutual fundsThis might be possible if a sufficiently large number of in their data bank for the period from January 1981investors consistently underestimate the probability that through December1990:The number of mutual fundsnegative information will be released about companies identified by their managers as socially responsiblethat are not socially responsible. Imagine, for example, funds increased from six in 1981to 32by the end of 1990.that conventional investors consistently underestimate Because thesefunds are new, we divided the 32into twothe probability that oil companies will find themselves in groups-the 17establishedin 1985or earlier and there-trouble because of oil spills. Declines in the prices of oil fore in existencefor at leastfive yearsby 1990and the 15company stocks following oil spills will lower the J:e- that were establishedafter 1985.turns on conventional portfolios holding oil company We measurethe excess returns of eachmutual fundstocks, but the portfolios of socially responsible invE~S- using Jensensalpha:8tors who shun oil stocks will not be affected. Ri -R, = ai + .8,{R.. -R,) + ei, To determine which of the three hypotheses isconsistent with the evidence, we turn first to a discu:s- where ~ is the monthly return on the value-weightedsion of existing studies of the performance of socially NYSEand Rr is the monthly return on the three-monthresponsible portfolios and then to our analysis of pE~r- U.S. Treasurybill.9formance. Table 2 presents the excessreturns on the funds established 1985or earlier. The excess in returns of 15 ofSTU~ES OF SOOALL Y RESPONSIBLE the 17funds are not statisticallydifferent from zero. One PORTFOl.K)S mutual fund has positive and statistically significantMost existing studies of the performance of socially excess returns and anotherhas negativeand statisticallyresponsible portfolios focus on portfolios that hold COD:- significantexcess returns. The average excessreturn forpanies with operations in South Africa versus portfolios the 17 socially responsible mutual funds is a loss ofwithout such companies. approximately6 basis points per month, or 0.76% per Rudd compared the characteristics of the S&P 5(KJ year. The results for the mutual funds established in 1986and later are similar. towith the characteristics of an optimized S&P 500 portf()-lio that excluded companies with operations in South We know from many studies that, on average,Africa.s He found that the extra market covarian<:e mutual funds trail broad stock indexes. It is thereforeinduced by excluding companies with operations in possible that, while socially responsiblemutual funds South Africa is small, resulting in an expected annual have low excessreturns relative to the NYSE, their return only 0.037% lower then the return on the S&P returns are higher than the averageexcessreturns of500. conventional mutual funds. To examine the relative Grossman and Sharpe compared the actual perfoJr- performance of socially responsiblemutual funds and mance of the NYSE with the performance of a ValUE~ conventionalmutual funds, we constructeda conven- weighted NYSE portfolio that excluded companies with tional mutual find benchmarkfrom the Lipper data. We operations in South Africa. 6They created a South Africa- first excludedfrom the Lipper list all sociallyresponsible free portfolio with risk (standard deviation) equal to the mutualfunds. We then divided the conventionalmutual risk of the NYSE by combining the South Africa-free funds into two groups according to the fund age. The portfolio with Treasury bills. Grossman and Sharpe first group containsall conventionalmutual funds estab- found that the risk-adjusted South Africa-free portfolio lished in 1985 or earlier and the second contains all FI1arK::iaIAnaIysts.bJrnaI / r..k)vember-Oecember 199364
  4. 4. Tci>Ie 2. Excess ~ ~1Cf1ed Usi~ Mcx"lthly fa ~ 17Socially ~1Si:>e MutI.a FLn:is ~istm in 1005 or earSCalvert SociallnvestmentFund 0 .0066 0.08 (0.0460)Dreyfus Third Century Fund -0.3339 -4.01 0.8424 0.8597 1/81-12/90 (-2.1440).EvergreenFund -0.0627 -0.75 0.9613 O. 8808 1181-12/90 (-0.3870)GreenspringFund 0.4136 4.% 0.3523 0.5431 8/83-12/90 (2.3500).IDS Equity Fund -0.1202 -1.44 1.0274 0.9182 6/81-12/90 ( -0.8570)New Alternatives Fund -0.1538 -1.85 0.9075 0 .8409 12/82-12/90 (-0.7670)New EconomyFund 0.1439 1.73 0.9378 0.9193 12/83-12/90 (0.9<XXJ)PamassusFund -0.2525 -3.03 1.1549 0.8142 1/85-12190 (-0.6600)Pax World Fund 0.0235 0.28 0.6970 0.8528 1/81-12190 (0.1770)Pioneer II 0 .0604 0.72 0.9710 0.9101 1/81-12/90 (0.4320)Pioneerill -0.1265 -1.52 0.9642 0.8216 12/82-12/90 (-0.5540)Putnam Health ServicesFund -0.1960 -,2.35 1.0532 0.7823 5/82-12/90 (-0.6960)Putnam OTC Emerging Growth 0.2014 2.42 .2795 0.7514 12/82-12190 (0.5390)Royce FD: Value 0.0953 1.14 0.7314 0.7570 1/83-12190 (0.4480)S<:udder Growth &. Income -0.2537 -3.04 0.8577 0.8625 1/81-12/90 ( -1.6180)SFr Environmental Awareness -0.5274 -6.33 0.9121 0.7091 5185-1290 (-1.2980)TransamericaCapital Appreciation 0.4785 5.74 1.1127 0.6618 10/85-12/90 (0.8020)Mean Excess Return -0.0630 -0.76.Significantly different from zero at the 5% level..Annualized excessreturns, i.e., monthly excess returns multiplied by U.conventional mutual funds established in 1986 or later. of 150 conventional mutual funds established in 1986 orLast, we constructed, by random drawing, a sample of later to serve as a benchmark for the 15 socially respon-170 conventional mutual funds from the first group to sible mutual funds established in 1986 or later. Table 3serve as a benchmark for the 17 socially responsible presents the estimated excess returns for all funds established in 1985 or earlier and a saznple The mean excess return of the first conventionalT~ 3. A Ca~ of Moothty ~ Retun"tS Socaty Responsible of arK1Ca~ ~ FurKis SociallyResponsibleMutual Funds ConventionalMutual Funds t-Statistics of the Difference Mean Monthly Standard :Number Mean Monthly Standard Number between the Excess Return Deviation of FundsExcessReturn Deviation of Funds MeansFunds Established1985 -o.~% 0.3298 17 -0.1402% 0.4279 170 -0.9199 or EarlierFunds Established1986 -0.2772% 1.0592 15 -0.0416% 0.4977 150 0.8521 or laterFinaroal Analysts JoomaJ / Novemrer -Docemrer 1993 65
  5. 5. benchmark group is -0.1402% per month or 1.680/0 per willing to receivelow returns as fair exchangefor chang-year. That mean excess return is lower than bu.t not ing the world. But not all socially responsible investorsstatistically different from the mean -0.76% per year attempt to change the world. As Domini noted:return of the corresponding group of 17socially re:;pon- ...sible mutual funds. The mean excess return of the Often soaally responsible Investors express thesecond conventional benchmarkis -0.0416% per month impetus to manage their money under social criteriaor -0.5% per year; it is higher than but not statistically as a des~e for an "integratio~ of money into ~nesdifferent from the mean excess return of -3.330/;;per self and Into the self one WIshes to become. Anyear for the corresponding group of 15 socially re~ipon- institution may strive for consistency between itssible mutual funds.iI mission and the way it achieves that mission. In Our results indicate that the market does not price both instances, this motivation comes from responsibility characteristics.Investors can e:<pect The provost of a Quaker college was asked why histo lose nothing by investing in socially responsible collegedid not invest in the manufaCturersof anna-mutual funds; social responsibility factorshave no effect ments. Did the board of trustees think it was goingon expected stock returns or companies cost of capital. to stop the annaments buildup? "No," he re-Our results might disappoint socially responsibleirlves- sponded, "our board isnt out to change the world.tors who hope to do well while doing good. They nught Were seekinga onenessbetween ourselvesand ouralso disappoint socially responsible investors who are Lord."uFOOTNOTES1. R. Lowry, GoodMoney: A Guide to Profitable SocialInvesting in rity market line is flatter than assumed by <Rm-rJ, the 90s (New York: W. W. Norton & Company, 1991),p. 56. estimates of Jensensalpha tend to be negative for high-2. A. Rudd, "Social Responsibility and Portfolio Perfor- beta portfolios and positive for low-beta portfolios (seeN. mance," G2lifomia Managemrnt Review 23 (1981), 55-6]. Chopra,J. Lakonishokand J. Ritter, "Measuring Abnormal3. E. Lee, "Its All Relative: Mutual Funds Discover SO<jally Performance: Do Stocks Over-react?" journal of Financial Responsible is in Eye of Beholder: Wall Street Journal, May Economics (1992),235-68).Our use of the value-weighted 31 20,1987. NYSE index makes this problem less severe than if an4. E. Shapiro, "RJR Nabisco May Issue Separate Class of equally weighted NYSE index were used. Stocks Tied to Firms Food Business," Wall Street Journal, 10. The Upper list contains "live" mutual funds, funds in February 1, 1993. existence at the time the list was compiled. It does not5. A. Rudd, "Divestment of South African Equities: How include mutual funds that existed dwing a portion of the Risky?" Journal of Portfolio Management, Fall 1979. sampleperiod but went out of existenceby the time the list6. B. Grossman and W. Sharpe, "Financial Implications of was compiled. Because funds that go out of existencetend South African Divestment," Financial Analysts Journal,July! to be poor performers, our data are possibly subject to August 1986. survivorship bias.7. A brief report of an analysis of the performance of 12 11. The substantial inflow of money into socially responsible sodally responsible mutual funds and money managers is portfolios during our 1981-90 sample period may have provided in J. A. Tepper, The Cost of Social Critel1a," inflated the returns of socially responsiblemutual funds. If Pensions & Investments, May 13, 1991. He finds (p. 34) that so, these returns might be lower in the future than they "the social managers underperformed in five of the six years. ..and had a risk-adjusted annual cost of 1.9%." were in the 1980s.8. M. Jensen, The Performance of Mutual Funds in the 12. A. Domini, "What is Social Investing? Who are SodaI Period 1945-1964," Journal of Finance 23 (1968), 389-41.5. Investors?" in Kinder, Lydenberg and Domini, eds., The SocialInvestmentAlmanac (New York: Henry Holt and9. Jensens alpha is a good measure of investment perlor- mance (see M. Grinblatt and S. Titman, "Do Benchm;lrks Company, 1992),pp. 5-7. Matter? A Study of Mutual Fund Returns" (Working paper, We thank Melanie Austin, Edward Chow, RogerHuang UCLA, 1991» and the bias due to timing is likely to be SJnall and Jay Ritter for their helpful comments, the Leavey (see M. Grinblatt and S. Titman, "Portfolio Performance School of Businessat Santa Oara University for research Evaluation: Old Issues and New Insights," Reviewof Finan- support, and Michael Upper and John Feeley of Upper cial Studies 2 (1989), 393-416). Because the empirical 5~- Analytical Servicesfor mutual fund data. Rnarx:iaI Analysts ..kJurr1a!November-December 1993 /00