MYTHS ABOUT SRI
SRI involves financial loss
The idea that socially responsible investment involves financial loss is only true if you’re incredibly thorough with your ethics. There is some confusion within the investment world about SRI. Often economists will equate ‘dark green’ SRI with ‘light green’ SRI and write the whole thing off as the stuff of tree-hugging hippies. ‘Dark green’ investment involves only investing in positively ethical sectors such as renewable energy and sustainable forestry. ‘Light green’ investment means negatively discriminating against companies that are considered past redemption (arms and tobacco).
Recent research suggests that significant portions of the market can be excluded from an investment universe without seeing any change in financial performance. This challenges the accepted wisdom that in order to ensure an optimum balance of risk and return you have to spread your investments as broadly as possible across the market. The typical economic argument states that if you limit the number of companies that you invest in then you increase the risk of financial loss. However, for reasons yet unknown (but probably to do with the volatile nature of unethical companies) an optimum balance of risk and return can be achieved with a portfolio that discriminates against up to 20% of the market.
And so, existing evidence suggests that quite robust ethical screening can produce a financial performance very similar to that of comparable non-ethical portfolios. Research into light green SRI shows that a significant share of the market can be eschewed without negatively affecting overall performance. Contrary to popular belief the arms industry only compromises 1.4% of the UK market. On this basis, it seems that to restrict our investment universe to 98.6% of the market ‘would not place us at ‘risk of significant financial detriment’. In other words, it is difficult to see how investments in the arms industry are particularly necessary for the economic well-being of an investment fund.
Ethical investment does not achieve anything
It is true that ethical investment does not make an enormous practical difference to the arms industry – other people will buy the shares and the arms companies continue as normal. However, in the absence of a democratic voice it is important that we use what we have at our disposal to make large scale political gestures. If a massive institution like Cambridge University, with its revered position in the British establishment, rejects the arms industry (and the policy decisions that support it) then we are one step closer to isolating the policy makers and warmongers as violent extremists.
Research into the financial viability of SRI
Between December 1990 and May 1999 the Ethical Investment Research Service (EIRiS) examined ‘the relationship between ethically screened universes and financial performance compared with that of an unconstrained universe, the FTSE All-Share Index.’ In order to reflect the diversity of criteria used by ethical investors and the different approaches these investors apply to define their universe of ethical stocks, EIRIS created five different ethical investment indices. These five indices were based on a variety of different ethical criteria and the investment universes compromised between 74% and 47% of the total market. Of these five indices, three outperformed the FTSE All-share index and only one index underperformed. Unsurpringly, the underperforming index was the most restrictive. To put this into context, the British arms industry compromises about 1.4% of the market value (figures taken from the end of 2004) of the FTSE All-share index. It is difficult to see how a deviation of 1.4% from the FTSE All-share index would make a substantial impact on investment performance.
Oxford Univerisity SRI Campaign In July 1993, 'Which Magazine' reported: “the average ethical fund has done as well as - and sometimes even better than - the average conventional fund”. The average UK ethical unit trust beat the average of all UK unit trusts by 13% (71% growth compared to 55% growth for the FTSE index) between 1991 and 1996.
The World Markets Company concluded its report on ethical investment by stating that it “can provide competitive returns”.
In a study entitled ‘Does Ethical Investment Pay?’ the Ethical Investment Research Service (EIRiS) conclude:
‘On average, ethical funds have lower total risk than funds without ethical criteria. This is a rather remarkable conclusion that runs counter to conventional wisdom outside the ethical investment world, but may also have implications for thinking within the industry. It is often supposed by financial commentators that because ethical investment can involve avoiding at least some large companies, it must be a more risky undertaking. This would appear not to be the case at the level of a portfolio of such stocks.’
The study suggests that ethical funds also have marginally lower returns yet, the lower total risk compensates for this loss and there is no significant difference to overall performance:
‘Balancing the merits of risk and return would be something each investor might want to do in a different way, but the balance offered by these funds does not look materially different from that offered by funds without ethical criteria.’
SRI Compass, another independent research service analysed the performance of some of the biggest European SRI funds between 2000-2003 and compared this to the risk/return behaviour of the markets in which they were invested. It concluded that there was ‘no major behavioural differences compared to “traditional” funds.’
Further studies have produced similar findings:
Hamilton, Jo and Statman (1993) and Statman (2000) compared the returns of ethical and non-ethical US funds to each other and to both the S&P 500 and the Domini Social Index (DSI), the oldest socially screened index, and concluded that there was no significant difference between risk-adjusted returns for ethical and non-ethical funds.
In the UK market, early studies by Luther, Matatko, and Corner (1992) comparing ethical funds to market-wide indices like the FT all-share index even provided some (arguably weaker) evidence that ethical funds tend to outperform general market indices.
Using more refined methodology, Gregory, Matatko and Luther (1997), found no significant difference between the financial performance of ethical and non-ethical unit trusts.
Bauer, Koedijk, Otten (2002) documented the theory that ethical funds in both the US and in Germany went through a ‘learning phase’ of significant under-performance in the beginning of the 1990s before beginning to match the performance of conventional funds in the late 1990s and early 2000s.’
This research agrees with the performance of the Church of England’s £4.3 billion fund which suffered in the early 1980s but has recently emerged as the second best perfomer of more than 1000 funds according to the Financial Times. The Church’s fund eschews investments in pornography, weapons, tobacco, alcohol and newspapers.