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Does it Really Hurt to be Responsible?

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Abstract

Prior literature on socially responsible investment has contended that excluding “sin stocks” from a portfolio (negative screening) will reduce performance and increase risk. Further, incorporating stocks of firms with positive social responsibility scores (positive screening) will improve performance and reduce risk. We simulate portfolios designed to mimic typical equity mutual funds’ holdings and investigate these propositions. We remove the potentially confounding influences of differences in manager skill, transaction costs and fees, and conduct a clean experiment on the effect of positive and negative portfolio screening. We find no difference in the return or risk of screened and unscreened portfolios. We conclude that a typical socially responsible fund will neither gain nor lose from screening its portfolio.

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Notes

  1. The majority of funds also currently screen for firms which are involved in Sudan (US SIF 2012). We include involvement in Sudan as one criterion in our “human rights” screen.

  2. See http://ussif.org/resources/mfpc/screening.cfm for a list of which screens SRI funds use—date accessed 27 July 2011.

  3. http://ussif.org/resources/mfpc/index.cfm?mf_type=BL&order—date accessed 8 April 2010.

  4. Specifically, US SIF identifies the following potential positive screens: environment (comprising climate/clean technology, pollution/toxics and other), social (comprising community development, diversity/equal employment, human rights and labour relations) and corporate governance (comprising board issues and executive pay).

  5. Note that we need to make an assumption about when a portfolio manager would add or delete a stock from the portfolio when the underlying index changes. We assume that deletions to the index are held in the fund until the end of the month and additions are added at the beginning of the following month. This results in our unscreened universe not necessarily comprising exactly 500 stocks in any given month.

  6. We are unable to test the effect of specific screens due to insufficient numbers of firms available for each screen. For example, there are less than 30 stocks with positive governance scores for half of the years in our sample (in 1 year only 13 stocks have a positive governance score).

  7. This sample period also has the advantage of allowing us to avoid using KLD’s 2010 ratings. In 2009, MSCI acquired RiskMetrics, which had previously acquired KLD and there are noticeable differences in the “strengths” and “weaknesses” criteria between 2009 and 2010.

  8. Results not displayed, available upon request.

  9. It must be noted that the majority of the alphas on our bootstrapped portfolios are insignificant, so it may not be appropriate to use these alphas to calculate differences between the screened and unscreened portfolios. Consequently, we also examine the alphas and replace any insignificant alpha with zero before taking differences. In each case, the upper and lower critical values become zero because the vast majority of the differences are zero. This result still upholds our findings of no difference between screened and unscreened portfolios’ alphas. We thank an anonymous referee for raising this point.

  10. We thank an anonymous referee for this suggestion.

  11. We note that positive screening is more likely to be an overlay on an existing diversified portfolio. Our results show that a purely positively screened portfolio is not undiversified. Therefore, we do not expect that adding a positively screened portfolio to an existing diversified portfolio will result in any significant loss of diversification.

  12. The industry returns data are from Kenneth French’s data library, as is the file which matches SIC and Fama–French industry classification codes. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html—date accessed 12 December 2011. We are grateful to Kenneth French for making these data available.

  13. We thank an anonymous referee for this suggestion.

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Acknowledgments

The authors thank Doug Foster, Lars Hassel, Steven Roberts, Paul Tan, Garry Twite, Geoff Warren, seminar participants at the Australian National University, Ecole Polytechnique, the University of Sydney Business School’s research forum on dynamics of investing responsibly and two anonymous referees for helpful comments. We thank Candice Tan for proofreading the manuscript. We also thank Chen Cheng, Kunjal Mehra, Yaokan Shen, Theingi Oo and Ying Xia for research assistance. We acknowledge the College of Business and Economics at the Australian National University for research funding.

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Authors and Affiliations

  1. Research School of Finance, Actuarial Studies and Applied Statistics, Australian National University, Level 4, College of Business and Economics Building 26C, Canberra, ACT, 0200, Australia

    Jacquelyn E. Humphrey & David T. Tan

  2. School of Aviation, The University of New South Wales, Old Main Building, Second Floor, Sydney, NSW, 2052, Australia

    David T. Tan

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  1. Jacquelyn E. Humphrey
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  2. David T. Tan
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Correspondence to Jacquelyn E. Humphrey.

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Humphrey, J.E., Tan, D.T. Does it Really Hurt to be Responsible?. J Bus Ethics 122, 375–386 (2014). https://doi.org/10.1007/s10551-013-1741-z

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  • DOI: https://doi.org/10.1007/s10551-013-1741-z

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