An important consideration of any investment strategy is the ability of the strategy to provide satisfactory results. Sustainable or socially responsible mutual funds and investment strategies are not immune to this line of investigation. Arguably, most investors who choose SRI investing likely emphasize the altruistic traits of the investments themselves over investment performance. However, even the most committed investor will eventually abandon SRI investments if performance isn’t acceptable.
So, do investments in socially conscious companies provide investors with adequate returns? According to Meir Statman in his article Socially Responsible Mutual Funds which appeared in the Financial Analysts Journal, yes, about the same as comparable non-socially minded investments.
Dr. Statman arrived at his conclusion after observing the returns of the Domini Social Index and socially responsive mutual funds from 1990-1998. As a researcher, it does stick out to me that this period is within a famously long bull market, so we would want to look at studies of other periods with different market characteristics for validation. We call this an out-of-sample robustness test in academic speak. I’ll be writing about some of the other studies in future posts.
Dr. Statman found that the Domini Social Index provided an annualized 19.02% while the S&P 500 generated 17.31%.
Of course, pure return is not the end of the story. It is important to be conscious of risk and understand its role in producing portfolio return. When comparing returns of two or more investments we need to account for risk in the comparison.
One measure of risk is beta. Beta is a ratio measure and relates risk to return. A beta of 1 means that an investment is expected to have the exact same risk and return as the overall market, however market is defined in that setting. In this case, as in most, the market is the S&P 500. Therefore, the S&P 500 by default will have a beta of 1. The Domini Social Index had a beta of 1.05 for the period studied. Because of this, the higher return of the Domini Social Index is expected to some degree.
Another measure of risk is standard deviation, or variability of return around an average. In the study period the standard deviation of the Domini Social Index was 14.19% and 13.23% for the S&P 500. Again, the DSI was riskier so the higher return is at least partially due to that.
To account for this difference in risk Dr. Statman used a modification of the Sharpe ratio in order compare the risk-adjusted returns of the Domini Social Index and the S&P 500. Even accounting for the higher risk the Domini Social Index performed better than the S&P 500.
Expenses – Passive Indexes vs. Active Funds
Statman also compared the return of 31 socially conscious mutual funds to the Domini Social Index and the S&P 500 over the same period. He found that the average return of the socially responsible mutual funds was about 6.26% less than the S&P 500 and 8.03% less than the Domini Social Index.
However, keep in mind these comparisons are of mutual funds and indexes. Indexes don’t have the management and trading expenses of mutual funds and these expenses play a big role in investment performance. This is one of the main benefits of investing in passive index funds which track indexes thereby significantly reducing costs. In this study all mutual funds, both socially responsible and conventional, trailed the index.
Socially Responsible or Conventional Mutual Funds?
Comparing SRI mutual funds to conventional mutual funds Dr. Statman found that the performance of the socially responsible mutual funds was better than the conventional funds. The 1.50% average expense ratio of the socially responsible mutual funds was very comparable to the average 1.56% for the conventional funds. Again, making an adjustment for the risk difference between the two groups of mutual funds Statman showed that the socially responsible mutual funds performed slightly better than the conventional mutual funds. The difference was statistically insignificant so we would conclude that performance was essentially the same between the two groups.
Values and Returns Don’t have to Conflict
The conclusion then is that socially responsible mutual funds and conventional mutual funds performed about the same. This is a win for socially conscious investors. Investors didn’t have to give up investment returns in order to choose investments that align with their values.