investing an expensive taste: James Saft
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[August 03, 2017]
By James Saft
(Reuters) - 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 which
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
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Discarded cigarette butts are seen lodged in a sidewalk grating in
Manhattan in New York City, May 8, 2017. REUTERS/Mike Segar
MIXED RESULTS, MIXED MOTIVATIONS
Adjusting those firms for risk, the study then looked at portfolios comprised of
companies scored on SRI criteria on an ascending basis and found that as
pro-social behavior in companies rises, stock market outcomes decline. The same
results, more or less, were found on an individual company basis, as opposed to
portfolios of companies.
None of this is a 'pure' view of the impact of SRI, however, in part because the
criteria used to screen companies on their SRI performance have different
objectives. Corporate governance, for instance, is generally about protecting
the rights and interests of shareholders from the depredations of insiders.
Environmental criteria, on the other hand, put a value on climate and other
considerations, effectively putting the interests of other stakeholders above
those of shareholders. It may well also be that the period studied, which
included both the great financial crisis and its monetary-policy-fueled
aftermath, is not a fair sample.
To be sure, the findings don't argue, per se, against the practice of socially
responsible investing, which investors may believe produces excellent results on
an 'all-in' basis taking into account its impact on more than simply financial
grounds. It is also true that the decision to opt for SRI investments is a lot
more simple for an individual making the call on her own behalf than it would be
for pension fund trustee acting for others.
There are also complex arguments to be made about the efficiency of the use of
capital markets, as opposed to outright regulation, as a means of encouraging
the desired behavior by corporations.
Instead, the upshot may be that SRI is like a cake; you can have it or you can
eat it, but not both.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(Editing by James Dalgleish)
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