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Alternative factors to consider in evaluating Socially Responsible Investment performance

As an investment manager with Rocky Mountain Humane Investing (  the most common question we hear from potential clients is “and advisor told me that socially responsible investing isn’t profitable” versus unscreened portfolio management.   In general the advisor providing the dogmatic opinion does not offer any foundation for their opinion but this is their chance to influence the potential client especially if they cannot offer an SRI option for the investor.   Unless you have a few arrows of your own in your quiver you may be quite likely shrug your shoulders and resign yourself to an unscreened portfolio versus a clean portfolio.

Probably due to the fact that I’m over 50 now with a repellent view of hyperbole and unsubstantiated opinions I have been uncomfortable with opposite view as well: socially responsible investing improves rate of return.  It has been my view based upon empirical experience of managing SRI portfolios for 20 years that SRI is not a significant determinant of investment performance.   SRI is a highly subjective practice where investors can have divergent opinions on industries and companies.   There is not unified screening standard amongst the SRI industry, each firm or fund makes their own decisions on screening criteria.  While some funds screen for only 3 or 4 issues there are other funds that screen over a dozen. 

Practitioners of SRI may draw attention that investors always assume a given level of risk with any equity investment but that the risk premium associated with SRI is less.    Case in point the risks associated with Tobacco, Asbestos or BP and the Gulf oil disaster.  However in my 20 years involved with socially responsible investing, screening stringency is often a matter of interpretation as BP was considered Best of the Lot for many years for funds that desired petrochemical exposure.

Let’s take a look at some of the academic studies that have touched upon the issue of the factors of SRI performance:

·         Moskowitz Award winner, John Guerard, Jr., director of quantitative research at Vantage Global Advisors, examined the returns of Vantage's 1,300 stock unscreened stock universe  and a 950 screened universe (The screens eliminated companies that failed to pass alcohol, gambling, tobacco, environmental, military, and nuclear power). He found "that there is no significant difference between the average monthly returns of the screened and unscreened universes during the 1987-1994 period.  The "unscreened 1,300 stock universe produced a 1.068 percent average monthly return during the January 1987-December 1994 period, such that a $1.00 investment grew to $2.77. A corresponding investment in the socially-screened universe would have grown to $2.74, representing a 1.057 percent average monthly return. There is no statistically significant difference in the respective returns series, and more important, there is no economically meaningful difference in the return differential."

Guerard’s conclusions are reinforced by other works:

·         “Socially Responsible Investment: Is it profitable” Dhrymes, Columbia University July 1997 June 1998.

Dyrymes concluded that: “that by and large the Concerns and Strengths of the KLD index of social responsibility are not consistently significant in determining annual rates of return.”

·         Socially Responsible Investment Screening Strong Empirical Evidence For Actively Managed Value Portfolios.  June 2001, revised December 2001 Stone, Guerard, Gultekin, Adams.

“No Significant Cost” means no statistically significant difference in risk adjusted return”.  In addition, they surmise that “the conclusion of no significant cost/benefit is not just a long term average.  It has remarkable short term consistency!”

In my opinion this report presents a balanced view in that they concluded that the during the time of the study 1984-1997 the stock market rewarded the growth oriented style and that the performance of SRI investments could become “brittle” if markets were to become risk averse and adopt a more Value oriented style……….a remarkably accurate presumption!

Could the performance of SRI funds which have exceeded or lagged their respective benchmarks be in part due to size (average capitalization from micro cap to large cap) and style (Value or Growth)?

Fama and French of Dartmouth University examined the annual rate of return and beta (volatility) of an unscreened universe of Growth vs. Value from 1928 to 2009 by dividing stocks into ten deciles (groups) based on book-to-market value, rebalanced annually and found that Value had the lower risk while Growth had the higher risk.  In addition, they found that the highest book –to-market stocks exceeded the return of the lowest book-to-market by 21% to 8% on average.   Stock valuation was as significant factor in the Fama and French study where the cheaper the equity valuation the better the return.

Market Cap size was important in the Fama and French study as well (1992).   Market cap size showed a significant edge to small and micro cap equities on a monthly basis.  *Monthly returns for the smallest 10% of equities were 1.47% versus 0.89% for the largest decile. 

It is our contention that there are attributes that could account for performance to equities other than social profiles and that concurrently a portfolio of socially screened equities with the highest book-to-value ratios could exceed comparative benchmarks largely due to valuation metrics and capitalization size.   In a case of pure cherry picking the monthly rate of return smallest market cap and lowest book value to market price was 1.63% versus .93% monthly for largest market cap and highest book value to market price.

I tested this theory using data supplied by the Social Investment Forum and Russell Index regarding the 10 year average rate of return for socially responsible mutual funds versus their respective benchmarks trends do emerge.

Data as of June 30, 2010


·         Russell Mid Cap Value Index was the top 10 year performer +7.55%.

·         Russell Mid Cap Growth Index returned -1.99%.

·         Russell 2000 Value returned +7.48%

·         Russell 2000 Growth Index returned -.92%

SRI Equity Large Cap performance (information provided by SIF)

4 mutual funds show positive 10-year average annual rates of return:

Neuberger Berman Socially Responsive +3.18% (Value)

Calvert Social Investment Equity +0.14% (Growth)

Walden Social Equity +1.46% (Value)

Parnassus Equity Income +4.65% (Value)

SRI Equity Small Cap performance

·         2 mutual funds from one mutual fund company showed a positive 10-year rate of return.

Ariel Appreciation +6.16% (Value)

Ariel Fund +5.62% (Value)

Disclaimer: While the sample size of SRI fund performance is very small.  I gleaned data from only the profitable SRI funds for the last 10 years.   The SIF forum does not show fund performance information for funds that have closed, merged or liquidated.   It would be a safe presumption IMO that funds that no longer exist were weak performers since money will flock to where it’s treated best.   Plus, hedge fund performance data was not available on the SIF site. 

The results do fall in line with substantial academic works (Fama and French, Lakonishok) and it is possible that SRI performance should be viewed thru the lens of Value/Growth and Market Cap size.

A logical question that must be asked upon reading this might be: “If small market cap and low valuations are the sweet spot for investing, then why are there so few funds or managers focusing on this strategy?”  Not to be obvious…………ok, well lets be obvious:  The small cap / low price to BV tends to be the focus of many private portfolio managers since our small size allows us the dexterity to invest in companies that are simply too small for billion dollar mutual funds.  Successful funds tend to outgrow the size/valuation strategy espoused by Graham as assets become larger and the investment selection becomes narrower.  But this topic should best be explored at a later date.

No holdings mentioned

Brad Pappas
President of Rocky Mountain Humane Investing
Allenspark, Colorado

*Monthly returns for Value and Glamour portfolios by Market Cap Categories July 1963-December 1990 Fama and French.








Disclosure: No positions