socially responsible investing critics, costs, and the future lloyd kurtz, cfa nelson capital...

Socially Responsible InvestingCritics, Costs, and the FutureLloyd Kurtz, CFA

Nelson Capital Management

May 25, 2005

Topics

Social Investors and Their Critics The Costs of Social Investing The Search for Social Alpha

Social Investors and Their Critics

Levels of the Debate Normative – “How Things Ought to Be”

Values-Driven Political Ethical Religious “SRI is misguided.”

Positive – “How Things Work” Fact-Driven Financial Economic Demographic “Here is evidence that SRI underperforms.”

Milton Friedman Illustration

Books Normative - Free to Choose Positive - A Monetary History of the United States

Quotes Normative: “The social responsibility of business

is to make money.” Positive: “In most cases [social] investing is

neither helpful nor harmful.”

Normative and Positive Commentators

Normative Positive

Supportive of SRI

Nat’l Conf of Bishops (1986)Peter CamejoPietra Rivoli (2003)

Meir Statman (2000)Marc Orlitzky (2003)Rob Bauer (2002)

Skeptical of SRI

Jon EntinePaul HawkenMark Schwartz (2003)

Chris Geczy (2003)Arthur Laffer (2004)Jeffrey Teper (1992)

A Proponent’s View

“Although all members of the Church are economic actors every day of their individual lives, they also play an economic role united together as Church. On the parish and diocesan level, through its agencies and institutions, the Church employs many people; it has investments; it has extensive properties for worship and mission. All the moral principles that govern the just operation of any economic endeavor apply to the Church and its agencies and institutions, indeed the Church should be exemplary.”

- National Conference of Catholic Bishops, 1986 Pastoral Letter

Another Proponent’s View

“We are on the side of the poor.”

- Nun, Diocesan Fiscal Managers Conference, mid-1990s

The Costs of Social Investing

When Normative Meets Positive The SRI Advantage: Why Socially Responsible

Investing Has Outperformed Financially Peter Camejo, founder of Progressive Asset Management

“Holy Grail Found: Absolute, definitive proof that responsible companies perform better financially.” Marjorie Kelly, Business Ethics magazine

Retail Customers Are Having a Bad Decade

Energy Stocks Have Led the Market

Performance Is Still OK vs. Other Funds Domini

*** Expense ratio: 0.95% AUM: $1,535 mm

Calvert / Vanguard **** Expense ratio: 0.25% AUM: $347 mm

Source: Morningstar

LT Performance Has Been Competitive "When we here at Morningstar have conducted

performance studies of socially responsible funds in the past, we've found that the offerings - as a group - perform about as well as funds that pay no attention to ethical considerations when building their portfolios.” - Hall (2004)

Bauer et al (2002) find no performance issues for mutual funds.

Geczy (2003) does historical analysis similar to Bauer and gets the same result.

New ETFs

iShares KLD Select Social Index No automatic eliminations except tobacco Cos. weighted according to social record Optimized to Russell 1000 Management Fee: 0.50% Ticker: KLD

PowerShares WilderHill Clean Energy Portfolio Index of 37 companies involved in clean energy Equal-weighted, quarterly rebalancing Management Fee: 0.50% Ticker: PBW

Costs of Social Investing

Diversification Avoidable

Implementation Small in % terms, but perhaps not in $ terms

Social Research De minimus?

The Search for Social Alpha

The LiteratureNumbers in parentheses show # of Moskowitz Prizes and Honorable Mentions.

Financial Academics (5)Journal of Finance

Working Papers

Financial Practitioners (2)Financial Analysts Journal

Journal of Investing

Management Researchers (4) Academy of Management Journal

Journal of Business

Independent Organizations (1)World Resource InstituteEnv. Protection Agency

EconomistsAmerican Economic Review

The Economic Journal

Research FirmsInnovest, IRRC,

Inst. Shareholder Services

Claimed Alpha is Very Issue-Dependent Areas Associated with Outperformance

Environment Derwall et al (2004) claim positive impact using Innovest data

100 Best Companies to Work For Kurtz and Luck (2003) claim positive impact

R&D Many studies show positive benefit

Areas Associated with Underperformance Unionization

Blanchflower (1991) claims negative financial effects

Attribution of KLD Catholic Values Index Northfield Fundamental Risk Model

EW vs. MW for BARRA 5/31/98 – 12/31/2004 Active return of 4 bps / month, of which…

+3 bps from Beta Policy -4 bps from Fundamental Factors +1 bps from Industries +3 bps stock specific

Chris Luck has shown same result (larger stock specific return) for Domini Social Index over long time periods using BARRA System.

What If There Were an SRI Effect? Wouldn’t it be arbitraged away?

Major players have considered this possibility: Calvert Group Parnassus Hedge Funds Barclays

Evidence of incorporation of social factors into valuations Enviroment: Dowell, Hart, and Yeung (2000) Corruption: Lee and Ng (2002) Disparity between financial and market-based measures:

Orlitzky (2003)

Help Wanted - The Best Opponent Financially sophisticated Principled, but not dogmatic Unburdened by a personal agenda Presents evidence, expects the same of you Seeking to persuade, open to persuasion Engagement is transformative

Let’s Do Social Investing BUT… Let’s do it for the right reasons Let’s do it well

Further Information

Online bibliography of SRI: http://www.sristudies.org

My SRI blog: http://srinotes.blogspot.com

My e-mail: lklyk@pacbell.net

Notes Bauer, Rob, Kees Koedijk, and Roger Otten. "International Evidence on Ethical Mutual Fund Performance and

Investment Style." Working Paper, January 2002. Blanchflower, David, Neil Millward, and Andrew Oswald. "Unionism and Employment Behavior." The Economic

Journal, July 1991. Derwall, Jeroen, Nadja Gunster, Rob Bauer, and Kees Koedijk. "The Eco-Efficiency Premium Puzzle." Erasmus

University Working Paper, May 2004. Dowell,  Glen, Stuart Hart, and Bernard Yeung. "Do Corporate Environmental Standards Create or Destroy

Market Value?" Management Science, August 2000. Economic Justice For All: A Pastoral Letter on Catholic Teaching and the U.S. Economy. National Conference of

Catholic Bishops, 1986. Geczy, Christopher C., Robert F. Stambaugh, and David Levin. "Investing in Socially Responsible Mutual Funds."

Wharton School, Working Paper, May 2003. Hall, Emily. "Evaluating Socially Responsible Funds." www.morningstar.com, July 7, 2004. Kurtz, Lloyd and Chris Luck. "An Attribution Analysis of the 100 Best Companies to Work for in America.“

Presentation to Northfield Investment Conference, Fish Camp, California, May 5-7, 2002. Laffer, Arthur B., Andrew Coors, and Wayne Winegarden. "Does Corporate Social Responsibility Enhance

Business Profitability?" Laffer Associates, 2004. Lee, Charles M.C., and David T. Ng. "Corruption and International Valuation:  Does Virtue Pay?" Cornell

University, Working Paper, November 2002. Orlitzky, Marc, Frank L. Schmidt, and Sara L. Rynes. "Corporate social and financial performance: A meta-

analysis." Organization Studies, 24, 2003. Rivoli, Pietra. “Making a Difference or Making a Statement? Finance Research and Socially Responsible

Investment.” Business Ethics Quarterly, July 2003. Schwartz, Mark. "The 'Ethics' of Ethical Investing." Journal of Business Ethics, March 2003. Statman, Meir. "Socially Responsible Mutual Funds," Financial Analysts Journal, May/June 2000. Teper, Jeffrey. "Evaluating the Cost of Socially Responsible Investing," in Kinder, Peter, Steven Lydenberg, and

Amy Domini, ed., The Social Investment Almanac, New York: Henry Holt, 1992.