Santa Clara University, my university, is a Catholic, Jesuit University, and its endowment fund follows its values: the sacredness of life, human rights, opposition to discrimination, opposition to nuclear weapons, and protection of the environment. We want our university’s endowment to earn high returns to support our students, faculty and staff. Do we sacrifice investment returns for our values?
A member of the Church of the Brethren faces the same question. “People from the church ask us fairly regularly whether we give up anything in terms of returns for our values. Often it’s phrased just that bluntly: “How much does it cost me to invest with you and exclude those things from my portfolio?” It turns out that Santa Clara University and the Church of the Brethren sacrifice no returns for their values. Indeed, evidence from my studies and those of others indicates that wise investors need not sacrifice returns for values.
Who are socially responsible investors?
Social responsibility means different things to different people, and socially responsible investors express different values. Some express a single value, such as protection of the environment, while others express several values, such as avoidance of tobacco, alcohol, and gambling. The differing values are reflected in the many alternatives to the term ‘socially responsible investing,’ including environmental, societal, and governance (ESG) investing, sustainable investing, green investing, ethical investing, mission based investing, values-based investing, and religion-based investing.
“For our church, investing according to socially responsible principles is more a matter of integrity than making a major difference,” said the member of the Church of the Brethren. “That is, if we believe tobacco has an overwhelmingly negative influence on society, we should not profit from it. If we made money on a tobacco investment, on the whole we’re worse off, even if we took every penny we made and reinvested it in beneficial programs… I occasionally see articles by investment columnists on the ‘sin’ funds that invest primarily in tobacco and alcohol, etc., advising people to take their profits from these funds and do good with them. That argument seems completely backwards to me, because the money is already out there supporting bad things.”
Socially responsible investors draw their inspiration from religion, family, books and their own experiences. “Although I was raised secularly for the most part,” said one investor, “my core values come from my family’s religious tradition, that is, that Jewish people believe in social justice. My grandfather emigrated from Eastern Europe when he was 14. He was one of the founders of a major union local and then went on to start his own business. When I was a teenager, I was doing some work for him when there was a strike at his business, and he told me I couldn’t cross the picket lines. My mother said, “You have to go to work and help him,” but my grandfather said, “You can’t do that.” Those are the experiences and the key framework that led me to emphasize feminist and workers’ rights in my investing.”
“I have an undergraduate degree in molecular biology and worked in biotech and the pharmaceutical industry for seven years,” said another investor. “At that point, I hadn’t taken any environmental classes and didn’t even have a strong interest in the environment. My interest arose later, largely as the result of reading books…I also began to recognize that I didn’t agree with how the pharmaceutical industry was run. I was uncomfortable with several ethical flaws ingrained in the system…Part of me recognized that it’s a business, and it’s not going to change, but I decided I didn’t want to participate any more… I eventually ended up going back to school for my master’s in environmental science and management.”
Do socially responsible investors sacrifice ‘doing well’ for ‘doing good’?
There are three alternative hypotheses about the relative returns of the stocks of socially responsible companies and conventional companies. The first hypothesis is the ‘doing good but not well’ hypothesis, where the returns of socially responsible stocks are lower than the returns of conventional stocks. This hypothesis might be true if the costs paid by a company for being socially responsible exceed the benefits to shareholders. For example, company managers might invest too much in social responsibility because they enjoy the personal honors they receive for being socially responsible, while shareholders receive lower returns.
The second hypothesis is the ‘doing good while doing well’ hypothesis, where the returns of socially responsible stocks are higher than those of conventional stocks. This is possible if managers underestimate the benefits of being socially responsible or overestimate its costs. Consider, for example, the managers of BP before the major oil spill in the Gulf of Mexico. They could have invested more in safety measures that would have done good, preventing the spill and the environmental damage it created, and they would have done well, saving the heavy costs of cleaning the spill and compensating victims.
The third and last hypothesis is the ‘no effect’ hypothesis where the returns of socially responsible stocks are equal to the returns of conventional stocks. The ‘no effect’ hypothesis might be true, for instance, when the extra costs of higher employee pay are equal to the extra productivity of more satisfied employees.
I have found in my studies that the returns of socially responsible mutual funds were approximately equal to those of conventional mutual funds, and that socially responsible indexes had returns approximately equal to those of conventional indexes. These studies are consistent with the ‘no effect’ hypothesis, where social responsibility neither increases nor decreases returns.
Yet perhaps the most important finding is that it is wise to avoid funds with high costs, whether socially responsible or conventional. The returns of socially responsible funds with high costs trailed the returns of socially responsible index funds and asset-class funds with low costs. The same is true for the returns of conventional funds. Socially responsible investors need not sacrifice returns for their values, as long as they invest wisely.
Statman, Meir, “Socially Responsible Mutual Funds,” Financial Analysts Journal, 2000
Statman, Meir, “The Religions of Social Responsibility,” Journal of Investing, 2005
Statman, Meir, “Socially Responsible Indexes,” Journal of Portfolio Management, 2006.
Statman, Meir, “Socially Responsible Investments, Journal of Investment Consulting, 2007
Statman, Meir, “Socially Responsible Investors and their Advisors, Journal of Investment Consulting, 2008
Statman, Meir, “The Expressive Nature of Socially Responsible Investors,” Journal of Financial Planning, 2008
Statman, Meir, and Denys Glushkov, “The Wages of Social Responsibility,” Financial Analysts Journal, 2009
Clearing the waters of BP’s oil will take years but we should not take years to clear the waters of socially responsible investing. BP’s stock was held by many socially responsible mutual funds before the April 2010 spill, including Pax World which professes sustainable investing. Pax cleansed itself of BP after the spill, selling its shares. The Dow Jones Sustainability Indexes (DJSI) branded BP “Sustainability Leader” in the years before the spill and wrote that “BP is leading its peers in corporate sustainability and is committed to shaping the oil and gas industry in the social and environmental aspects of business…Eco-efficiency indicators show that BP delivers well on its lower carbon growth strategy by increasing production whilst stabilizing greenhouse gas emissions.” DJSI cleansed itself of BP by expelling it from its indexes after the spill, writing that “The extent of the oil-spill catastrophe in the Gulf of Mexico and its foreseeable long-term effects on the environment and the local population – in addition to the economic effects and the long-term damage to the reputation of the company – were included in the analysis leading up to BP’s removal.”
The origins of the social responsibility investment movements are in values, most often rooted in religion. Weapons and slavery offended the religious tenets of the Quakers who settled North America, and the Quakers refused to invest in them. We know the screens used by the Quakers as “negative screens,” aimed at excluding companies that offend particular values of investors without regard to the cost of such exclusion. The original socially responsible investors were modest in their expectations from such investments. The provost of a Quaker college was asked why his college does not invest in manufacturers of armaments. Did the college’s board of trustees think it was going to stop the armament building? “No,” he responded, “our board isn’t out to change the world. We’re seeking oneness between ourselves and our Lord.”
Values differ and negative screens vary along with them. The Amana funds screen out interest-paying investments, such as bonds, because they violate the Islamic prohibition on interest or riba. The Ave Maria Catholic Values fund screens out stocks of companies associated with contraceptives, abortions, or benefits to unmarried partners of employees. Ave Maria disposed of the stock of the Eli Lilly pharmaceutical company when it began offering benefits to unmarried partners of its employees. Yet Eli Lilly would not have been excluded by Meyers Pride Value Fund which appealed to investors eager for inclusive policies toward gays and lesbians.
Socially responsible investing with negative screens is easy. We can exclude stocks of tobacco, alcohol, or gambling. We can even exclude all three. But complications arise when positive screens augment negative ones. Positive screens confer preferences on companies with positive characteristics, such as good employee relations, solid environmental records, or strong corporate governance. But positive screen open the door to critics. Paul Hawken, the co-founder of Smith & Hawken, criticized the Domini fund for straying away from purity by including in its portfolio companies such as McDonald’s, but Amy Domini defended her inclusion of McDonald’s as a good choice, even if an imperfect one. “I personally may prefer slow food to fast food. I personally prefer the ambiance of organic over non-organic. But I don’t have a mandate from the public to avoid fast food… When I look at McDonald’s versus [other companies in] the fast-food industry, I see them on a path toward human dignity and environmental sustainability. I can live with myself for investing in McDonald’s.”
It is easy to empathize with Amy Domini. After all, we would have no friends if we insisted on associating only with perfect ones. Indeed, we would not have us as our own friends if we were to demand perfection. Corporations are no more perfect than people. Anadarko Petroleum had a very low overall score on social responsibility by the criteria of community, corporate governance, diversity, employee relations, environment, human rights, and products. Xerox had a very high overall score and so did IBM. Yet Anadarko’s score on employee relations was better than Xerox’s and its score on corporate governance was better than IBM’s. Socially responsibly funds cannot choose perfect companies because perfect companies do not exist. Instead, they choose good companies. Yet people perceive the selection of a company into socially responsible funds as a ‘perfect company seal’ and stand ready to ridicule funds when one their stocks, such as BP, turns out to be less than perfect.
The socially responsible community can free itself from its bind by returning to its negative screens origins, abandoning positive screens. A mutual fund which includes BP because it has a solid environmental record will be embarrassed by news that BP is responsible for an oil spill, but a mutual fund which excludes Altria because it produces cigarettes would never be embarrassed by news that news that Altria also has good employee relations or high stock returns.
We can create a suite of low-cost index funds with negative screens appealing to particular groups of investors. One fund might exclude interest paying companies, another might excludes companies producing contraceptives, yet another might exclude companies producing tobacco. Successful funds will combine exclusions that appeal to large enough investors segments. A fund that excludes tobacco, alcohol and gambling might succeed, but one that excludes both alcohol and contraceptives might not. Socially responsible investors would save a lot of money with such low-cost index funds, money they can use to change the world.