John Wesley probably had no idea what he was starting when, 250 years ago, he planted the seeds for what is known today in financial circles as socially responsible or sustainable investing. In his sermon “The Use of Money,” the Methodist founder urged his followers to forswear business practices that harmed their neighbors and to avoid industries like tanning and chemical production that could harm the health of workers.
There is no better way to put Wesley’s ethos into a modern-day context than to describe a chart I recently ran across while preparing a talk on business ethics to give at the Vatican in Rome. It showed in stark ascending lines that, over the two years ending in May 2011, the Ave Maria Catholic Values Fund, which eschews stocks contrary to church teaching, performed well above the USA Mutual Vice Fund, which invests only in arms, tobacco, alcohol and gambling (see graph right).
Case closed. Or was it, I wondered? The “church versus vice” chart was amusing, but is there any concrete evidence that an investment strategy favoring companies that support the environment, consumer protection, human rights, diversity or sundry other virtues actually provides better returns than one that supports the “sin stocks”—or the S&P 500, for that matter?
Why should anyone care? Here is one reason. Socially responsible investing has become a huge market around the world. According to the Social Investment Forum Foundation, sustainable investing has been growing at a faster clip than the much broader universe of conventional investment assets under professional management. At the start of 2010 the foundation reported professionally managed assets pegged to socially responsible investing strategies stood at $3.1 trillion, an increase of more than 380 percent from $639 billion in 1995. As a result of this bullish trend, nearly one of every eight dollars professionally managed in the United States today—12.2 percent of the $25.2 trillion in total assets tracked by Thomson Reuters Nelson—is in some way tied to socially responsible investing.
Even more revealing, during the market tumult of 2007 to 2010, assets from socially responsible investing enjoyed healthy growth, while the overall stock universe remained roughly flat.
Positive Investing
Although the practice is hundreds of years old, the modern-day shift toward ethically grounded investments took off in earnest during the culturally and politically restless 1960s. Boycotts and economic development projects spearheaded by Dr. Martin Luther King Jr. provided a model for socially conscious investing, while a vocal group of investors opposed to the Vietnam War took out their fury on companies like Dow Chemical, a manufacturer of napalm. In the 1970s and ’80s, many large institutions shunned investments in South Africa because of that country’s detested practice of racial apartheid. More recently, socially responsible investing has meant reaching out to companies with strong environmental credentials or to corporations that take governance, transparency and shareholder engagement seriously.
The latest version of socially responsible investing is known as “positive investing,” taking a financial stake in companies or institutions committed to making a meaningful societal impact. Money invested in a community development institution or fund, for example, may be used to alleviate poverty, support “green” businesses or promote economic projects like low-income housing.
But the question remains: Can socially or ethically responsible investing, for all its virtues, actually yield better returns than the market averages?
Unfortunately, the evidence is more anecdotal than scientific. An article published in Fortune in 2009 described how the small, socially conscious, private investment firm of Lowell Blake and Associates, based in Boston, sidestepped bank stocks because it believed these institutions made money by encouraging consumers to go into debt. Nor did the firm invest in tobacco companies, defense contractors or any enterprise it believed harmed the environment. Instead, it looked carefully at a company’s governance policies, balance sheet (there must be very little debt) and product quality. That unconventional approach, reported Fortune, seemed to be working. In 2008, the firm’s holdings outperformed the S&P 500 by more than 4 percent; over the previous seven years they returned 36 percent while the S&P 500 lost almost 1 percent. Recent research by Craig Metrick, principal and U.S. head of responsible investment for Mercer, indicates that mission-related investments have generally performed better than “mainstream fixed income investments.”
Other research is less clear. A study conducted by the financial economists Lobe, Roithmeier and Walkshäusl created a set of “sin indexes” consisting of 755 publicly traded stocks around the world aligned with the “Sextet of Sin”: adult entertainment, alcohol, gambling, nuclear power, tobacco and weapons. They compared the stock market performance of these stocks with the socially responsible investment indexes they also built. They found no compelling evidence that either ethical or unethical investments made a significant difference in their market performance.
The Well-Managed Business
What can make a difference in terms of higher returns on sustainable investments is a focus on businesses that are well managed. These are companies, more specifically, that are known to have a strong culture of integrity, respect for their shareholders and senior managers who are driven by long-term value creation. Thorough research by skilled investment analysts can help to identify opportunities to pursue and risks to avoid based on a variety of generic socially responsible themes. These include climate change, environment and pollution, pandemics (like H.I.V./AIDS), water, human capital/training/work environment, lobbying, corporate governance/transparency, demographics, shareholder agreement, bribery/corruption and globalization.
Wall Street wisdom has been that if you invest with a social conscience, you must be ready to sacrifice performance. That mindset is changing, although additional studies into this fascinating field are needed to provide clarity and guidance to an always skeptical investment community. The conclusive evidence will appear when investment managers who emphasize well-managed companies with sustainable investments actually achieve consistently superior returns.
Why is this difficult to derive a solution? Take $1,000 of the S&P index, assemble a portfolio of unacceptable securities and short it against the index in proportion to their weight in the index at t=0. The net return will demonstrate whether an unbiased portfolio with this social precept performs better or worse.
quod demonstrandum proponebatur, nonne?