Socially Responsible Investing part 9: Does ethical investing compromise investment performance?
October 10th, 2008Socially Responsible Investing 10 CommentsLet’s explode one myth right now – ethical investing does not generally result in sub standard financial returns, as often claimed.
That said, it does not necessarily improve investment performance either.
The relationship between ethical investment strategies and investment performance has been the subject of considerable research over the past twenty years. Naturally, different studies, using different methodologies and approaches, have produced differing results. (Click here for a summary of the most significant studies)
Nevertheless, the majority of studies support the conclusion that investing in a socially responsible fashion does not have any material impact – positive or negative – upon anticipated financial returns over the longer term.
The evidence
To be sure, there are some studies which do appear to indicate that SRI funds may underperform to a small extent relative to the broader investment market. One such study, conducted in my home country of Australia, measured the performance of eighty-nine ethical funds over a twenty year period from 1986 until 2005. The study found that on a risk adjusted basis, ethical funds underperformed the broader market by an average of approximately 0.88% per year over the twenty year period. (click here to view PDF abstract)
But these results must be balanced against other studies, which tell a more positive story. A UK study, for instance, by independent investment consultants Jewson Associates, found that “UK and global ethical investment funds outperformed the market over one, three and seven year periods.” (refer Financial Times report)
Furthermore, in 2002, an award winning Dutch paper, which analyzed investment returns over an eleven year period in Germany, the UK and the U.S, concluded that “there seems to be no statistically significant difference in returns between SRI funds and conventional funds.”
Are ethical funds more risky?
However, the UK report mentioned above indicated that ethical funds carry a slightly greater amount of volatility and a higher risk profile when compared to conventional funds.
The primary reasons for this are two-fold. First, ethical funds tend to invest more heavily in smaller companies, particularly those which offer promising new technologies. Second, ethical funds tend to avoid some sectors which are considered to be ‘defensive’ such as the oil industry.
This would appear to make logical sense, and one could see why ethical funds may carry slightly greater risk than conventional funds for these reasons.
Paradoxically, Professor Bauer, who conducted the Dutch study mentioned above, observes that ‘SRI funds seem to be a little less risky than conventional funds.” (No reason for this observation was given in the article which I read)
Accordingly, whilst ethical funds would appear to be more risky, agreement as to whether this is indeed the case is not uniform.
What does all this mean?
When it all boils down to it, the overwhelming majority of historical evidence suggests that ethical funds offer competitive investment performance when compared to their non-ethical counterparts.
Contrary to the assertions of many critics, ethical investment strategies in general appear to have little if any impact upon anticipated investment performance – either positive or negative.
Investors who wish to consider SRI funds can do so comfortably in the knowledge that such an approach does not generally diminish anticipated financial returns.
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