1. The Effect of the Business Cycle on the PERFormance OF SOCIALLY RESPONSIBLE INVESTMENTS Dissertation Proposal Defense Andrea Roofe May 5, 2010
2. What is ‘Socially Responsible Investing’? Socially responsible investing (SRI) “…integrates environmental, social and governance factors into investment decisions" (Social Investment Forum, 2010a) www.socialinvest.org
3. Outline of the presentation Background Research Questions and relevance of the study Theoretical perspectives Methods Preliminary findings
5. SRI movement: Historical Background need to express personal value system through investing:religious and secular values. slave trade and war (17th - 19th century) alcohol, tobacco, firearms and gambling activities (1920s) civil rights, the Vietnam War, apartheid, and consumer issues (1960s-80s) corporate governance and sustainability issues (1990s and early 21st century)
7. Research Questions Does socially responsible investing deliver financial value? Does the SP-FP relationship vary across phases of the business cycle? To what extent are net excess returns attributable to fund-SRI index differences, and index-benchmark differences? 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?
8. Relevance of the study Public concern with issues in corporate governance (ENRON, 2008 crisis in the financial markets). Size of SRI market: 70 inst investors representing US$4 trillion. 260 mutual funds (AUM>$200b) in 2007. 55 funds (AUM~$12 billion) in 1995. Paucity of research into the performance of SRI equity mutual funds during a severe economic downturn. 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)
10. Review of the literature Stakeholder Theory and CSR-the basis for SRI The social performance-financial performance (SP-FP) connection The SRI Investment Process Business Cycles and SRI Recent trends in SRI
11. Definitions Social performance-rating assigned to a company based on investor perception of a company’s social responsibility. Financial performance-the long-term profitability of the corporation or the excess returns delivered by the SRI fund. SP-FP link takes place at 2 levels: CSR->FP by the firm CSR-> high SP rating -> SRI investment
12. -Stakeholder theory-the rationale and foundation of SP Stakeholders include all entities in the society whose interests or welfare are affected by the company’s actions (Freeman, 1984) Stakeholder interest is financial only (Friedman, 1970) 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)
13. SRI and the parallel SP and FP link SP-FP (corporate): SP-> FP through competitive advantage SRI (investor): financial returns and utility (satisfaction) of social investing
14. SRI investor attitude toward risk Adaptation of Tobin’s Liquidity Preference Theory as behavior toward risk (1958). Risk lover-gives up financial returns in exchange for more risk. Risk averter (diversifier)–balances risk, return-at higher levels of risk, more returns needed in exchange for the same amount of risk Risk averter (plunger)-higher returns in exchange for more risk-accepts more risk in exchange for the same amount of return.
15. Social Criteria Preference as Behavior toward Risk SRI investor tradeoff among risk-return-social performance (Beal et al., 2005; M. Moskowitz, 1972; M. Moskowitz, 1997). Ethical financial-investor is risk averse on both financial and social criteria. 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.
16. Relevance of the Social Criteria construct This attempt to define a new construct in the SRI-financial literature should help in defining the implications of behaviors identified by the hypotheses. In spite of the focus on financial returns, SRI is a behavioral phenomenon.
18. SP-FP theoretical perspectives Linked to perspectives on stakeholder theory: Companies engaged in social performance deliver superior financial performance. The benefits of SRI outweigh the cost of screening the investment. SRI is consistent with Prudent Investor Rule (fiduciary duty to consider well being of the trust)
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20. SRI limits the trustee’s universe of stocks (financial stakeholder view-Prudent Man considers financial returns)
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22. SP-FP empirical findings Mixed mostly positive empirical results of relationship between SP and FP Some neutral or inconclusive (UNPRI, 2007; Orlitzky, Schmidt &Rynes, 2003; Margolis and Walsh, 2001).
23. Business Cycles and SRI Weak economy – risk of loss-high expected return (Fama & French, 1989) Fund manager skill required (Siegel, 2009a) Strong economy – less risk of loss-lower expected return. Does the inclusion of SRI screens add value to the investment process? Do religious or vice funds perform better during good/bad times?
24. Trends in SRI Specialized funds-environmental, religious, vice, international, country /regional-there is a fund for every need! UNPRI –SRI acceptance by financial community. B Lab/B Corporation certification-development of formal standards and audit procedures for SP. SEC addition of climate risk to list of disclosures.
27. Hypotheses Hypothesis 1(a) There is no difference between the performance of SRI indices and their conventional benchmarks during periods of economic expansion. Hypothesis 1(b) There is no difference between the performance of SRI indices and their conventional benchmarks during periods of economic contraction.
28. Hypotheses continued Hypothesis 2 SRI delivers positive net excess returns (after expenses). Hypothesis 3a Religious funds have greater excess returns than vice funds, and their conventional benchmarks. Hypothesis 3b The Vice Fund delivers greater excess returns than traditional SRI funds, and religious funds.
30. The model Fama-French model Excess returns= a + beta*(rm-rf) + c*SMB + h*HML 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 Carhart 4 factor model Excess returns= a + beta*(rm-rf) + c*SMB + h*HML + j*MOM MOM "Momentum" is the empirically observed tendency for rising asset prices to raise further. Momentum leads to price bubbles.
31. Markov switching regime (2 states) Each observation is weighted by the probability that it occurred during a period of expansion or contraction-Markov 2 state regime switching model Probabilities are based on the value of R1Y1 (dividend yield-current source of information) Excess returns= Si*alpha + Sibeta*(rm-rf) + sic*SMB + sih*HML + sij*MOM + sip*R1Y1 0≤ p(s) ≤1 s = 1, recession or 2, expansion
33. Method-RQ1 Compares historic difference between SRI index returns and that of the conventional benchmark. Compares risk adjusted difference between SRI fund returns and total returns on related SRI indexes. Fama-French 3 factor model Carhart 4 factor model
34. Analysis-RQ1 and RQ3 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. 2. Compare historical data: correlation coefficient/R-square standard deviation (volatility) Sharpe Ratio Value at Risk (VaR)