Other benefits like peace and a livable planet notwithstanding, the financial cost of socially responsible investing appears to be high.
Socially responsible investing (SRI) has been one of the few boom areas of active management. Funds managed to SRI mandates soared to $8.1 trillion in 2016 from just $1.4 trillion in 2012, according to the Forum for Sustainable and Responsible Investment.
Rather than simply gunning for the highest return, SRI seeks good returns but screens companies for other factors like environmental and social impact. Though the range of SRI screening criteria varies, they generally include a company’s impact on the environment, the communities in which it operates and its corporate governance.
The academic findings on the success of SRI judged by traditional investing criteria have been mixed. A 2009 study found that “sin stocks” like alcohol, weapons and tobacco deliver about 2.5 percent of extra or “abnormal” return a year compared to the general market. Other studies, however, have shown mixed results on the effect in practice of SRI, with some showing worse overall results and some better.
A new study from the University of Rome and the University of Groningen looks at the impact of a preference or “taste” for SRI holdings and finds it to be both large and negative.
“With respect to the taste effect, investors seem to pay a price in terms of lower returns due to their preference for SRI. The premium related to the responsibility score, the price of taste, is negative, significant and stable across all model specifications,” Rocco Ciciretti, Ambrogio Dalò and Lammertjan Dam write in a paper released in June.
Studying 1,000 global firms between 2005 and 2014, the study found evidence that a preference for SRI led to an underperformance of a huge 4.8 percentage points annually.
The authors argue that the trend towards SRI can be explained in one of two ways: SRI assets have better risk characteristics; or, investors have a taste for them for other reasons.
The risk aspect was well illustrated last week when tobacco stocks fell sharply on news that the FDA may seek to limit addictive nicotine in cigarettes. (It must be said that tobacco companies, risks aside or perhaps because of the risks, have massively outperformed the broad market for decade after decade.)
The new study attempts to control for the risk characteristics that might attract or repel SRI investors in order to get a cleaner view of the impact that a preference for these stocks has on returns. This is done, in part, by identifying which firms score best on a range of factors from corporate governance to community involvement to environmental stewardship.