Are 'Socially Responsible Investing' Funds Worthwhile?

So-called Socially Responsible Investing is a big trend on Wall Street these days. ETF investors can get in on the gambit with the iShares KLD Select Social Fund (KLD). The fund which the index tracks selects stocks from the Russell 1000 (an index of large and mid-cap domestic stocks) screened based on non-economic criteria that KLD considers socially desirable, such as workplace diversity, product quality & safety record, environmental friendliness, etc. The index also excludes all tobacco-related stocks, but does include some holdings that might surprise you, such as Exxon Mobile (XOM).

That’s all fine. However, the problem is that socially responsible investing probably doesn’t work. I have been unable to find any convincing evidence which shows that SRI benefits anyone, either by delivering superior investment returns, or by encouraging companies to “do the right thing” in order to be included.

But the real kicker is that KLD is likely to underperform the Russell 1000 going forward as well, because by selecting stocks based on non-economic criteria, the index provider has created a portfolio with inferior fundamentals.

Specifically, compared with the Russell 1000 from which they are drawn, the stocks in KLD have delivered slower earnings growth over the past five years, are expected to do so again this year and going forward over the long term (Figure 1). Despite this, KLD trades at a price-to-earnings premium versus the Russell 1000, at 15.6x and 14.8x 2008E EPS, respectively.

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On top of all that, KLD charges you substantially extra for the privilege. The annual expense ratio for KLD is 50 basis points, compared with just 15 for the comparable iShares Russell 1000 fund (IWB). How responsible is that?

The net result of all this is that while you may be feeling better about yourself for investing “responsibly,” you’ll probably also feel poorer, at least in the long run. So if you want to do good, get rich investing wisely, and then give your money away to a worthy cause.

Comments

[danno:]

This guy has no idea what the heck he's talking about. There are lots of studies showing that SRI can and often does outperform from Citibank, Rabobank, and a variety of other organizations. Doesn't look like this guy did much research at all. Amateurs shouldn't be writing columns - especially when they defame a whole class of investing. Having been at treasury level at a major Fortune 500 company as well, I also know that SRI did actually change our behavior.

2008 May 02 08:26 AM

[MacFox:]

AS a 'mature' MBA graduate who undertook his dissertation on the adoption of SRI within the asset management industry, Michael appears to be simply trotting out the 'standard' argument/analysis from those who do not support the philosophy of SRI. Find any financial/return data to support your postion and present it as a 'fait accompli' of the evidence that adopting a SRI approach reduces potential returns. In the meantime, as Danno states, ignore all other evidence that supports the positive side of SRI.

In the quantative analysis I carried out of academic studies into positive/negative returns through the adoption of SRI, the starting point, i.e., whether or not the researchers were in favour or not of SRI, often determined the outcome (though not always). In other words if the researcher felt strongly about SRI, they found a strong correlation between the 'enhanced' returns and the adoption of SRI by asset management groups.

2008 May 02 10:01 AM

[Panskeptic:]

I don't know why people keep writing this article. I guess there's a new generation of "tough guys" coming on line periodically who have to torture the data to fit their political bias. This guy seems even more ignorant than usual. "Yawn."

2008 May 08 02:05 AM