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There's Nothing Special About Socially Responsible Investing

That smug feeling of superiority comes free.
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(Getty Images)

(Getty Images)

On its face, socially responsible investing seems like a have-your-gluten-free-organic-fair-trade-certified-cake-and-eat-it-too proposition. It's a truism that the best investors leave their personal politics and moral attachments locked away in a soundproof chamber while going about their speculative business.

There's a clear intuitive reason for this: Basically, we shouldn't let our ideas of what ought to be cloud our view of what is. But there's also venerable theoretical underpinning. Market portfolio theor holds that the more investing options one has, the better one's returns will be. Since SRI weeds out dirty and sinful options, it limits the number of funds a manager can choose and, theory holds, generates lower returns. As Cliff Asness has argued, this is as it should be; after all, virtue is its own reward. (SRI funds do not share this view.)

There's a problem with the theory. Namely, practice:

We conclude that socially conscious funds (as measured by Sustainability) have neither higher nor lower risk-adjusted return than other funds. Socially conscious investors, therefore, do not appear to incur any performance penalty for their philosophical choice.

That's the conclusion from a recently published study, Do 'Good Guys' Finish Last? The Relationship between Morningstar Sustainability Ratings and Mutual Fund Performance, from Eli Lilly financial analyst Anna Krukover, Steven Dolvin of Butler University and Jon Fulkerson of the University of Dayton. Using sustainability metrics Morningstar began providing in 2016, the team grouped mutual funds by ESG rating and tracked performance over four years. As it turns out, socially responsible funds are basically indistinguishable, return-wise – as others have previously found, albeit with less standardized data-sets than Morningstar's.

There were some minor differences between SRI and ordinary mutual funds. For one thing, SRI funds tended to skew more toward large-cap companies. But overall, investors weren't “paying” for that special feeling of extracting surplus only from nice companies. Neither did SRI funds did not outperform – a case that ESG proponents sometimes make – but they did see more stable inflows than other funds.

There are a few ways one could interpret the findings. First, that the dataset is too limited and it means nothing. Second, that while market portfolio theory still holds, the harmful act of limiting one's investing universe is counterbalanced by the fact that prioritizing ESG principles also happens to prioritize sound financial management. As a Bank of America Merrill Lynch report found last year, for instance, “an investor who only held stocks with above average-ranks on both Environmental and Social scores would have avoided 15 of the 17 bankruptcies we have seen since 2008.”

Or maybe market portfolio theory isn't as sacrosanct as we thought. Perhaps it's true that the more options a manager has, the better a fund will do. But more options also means more bad options.


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