INSIGHTS IN RISK AND RETURN OF SOCIALLY RESPONSIBLE INVESTING: WHAT WE CAN LEARN FOR THE FUTURENadja GuensterECCE, Maastricht University Haas Center for Responsible Business, UC Berkeley

TBLI, November 9, 2012

Institutional investors motivate their decision to follow SRI strategies with financial performance:

UNPRI (http://www.unpri.org/principles/):

“...we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios...”

Calpers’ tobacco divestment • Poor performance • No ethical considerations(http://www.nytimes.com/2000/10/29/business/investing-diary-calpers-puts-tobacco-behind-it.html)

PERFORMANCE OF SRI STRATEGIESThe Practitioner’s Perspective

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PERFORMANCE OF SRI STRATEGIESTheoretical Perspective

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Efficient Market Hypothesis: Prices reflect all publicly available information and prices instantaneously adjust to reflect any new public information

If all information is incorporated in prices

No predictive power for future returnsIt is not possible to use ESG information to earn abnormal

returns (as long as this information is available to more investors)

Restricting the universe worsens portfolio’s risk-return tradeoff

SRI portfolios underperform

Finance Theory (EMH) Practitioner view

Let’s look at the empirical evidence!

THE CONTRADICTION

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Two common strategies:1. ESG strategies2. Sin stocks

ESG Portfolios:• Top: best performers on E, S, or G• Bottom: worst performers on E, S, or G

Abnormal returns “Risk-adjusted” returns• Different risk-factors taken into account

EMPIRICAL STUDIES

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ENVIRONMENTAL PERFORMANCE AND RETURNSOverview of studies

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Study Data Period Abnormal return (best-worst)

Derwall et al. (2005) Innovest 95-03 5.06%*

Kempf and Osthoff (2007) KLD 91-04 3.02%

Statman and Glushkov (2009) KLD 92-07 2.47%

Studies find positive abnormal returns (not all statistically significant)

SOCIAL PERFORMANCE AND STOCK RETURNSOverview of Findings

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Study Data Social Criterion Period Abnormal return (best-worst)

Statman and Glushkov (2009) KLD

CommunityDiversity

Employee RelationsHuman Right

Product

92-07

3.96%*0.34%

3.73%*-2.57%2.02%

Derwall et al. (2011) KLD Employee Relations 92-04

92-085.62%2.81%

Borgers et al. (2012) KLD Stakeholder Index 92-04

04-093.52%*-2.30%

Positive returns in earlier periods…. but after 2004 no evidence of

positive returns anymore

CORPORATE GOVERNANCE AND STOCK RETURNSOverview of Findings

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Study Data Period Abnormal return (best-worst)

Gompers et al. (2003) 90-99 IRRC 8.5%*

Core et al. (2005) 90-9900-03 IRRC 8.25%

-1.56%

Bebchuk et al. (2011) 90-9900-03 IRRC 5.88%* to 14.76%*

-3.60%* to 4.2%*

1990-1999: large positive abnormal returnsAfter 2000: no evidence of abnormal returns

Institutional investors were right: Investing in high ESG firms was associated with better investment performance in the 90s

However, for S and G the effect dimished after 2000/2004

Investors learned to appreciate positive effect of S and G on profits

Top S and G performers valued higher than worst performers

ESG AND INVESTMENT PERFORMANCE

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Hong and Kascperzyk (2009) find that norm-constrained institutionalinvestors shun “sin stocks”

Triumvirate of Sin: Alcohol, Tobacco, and Gambling

Only 23% of shares held by institutions instead of 28%; lower analyst coverage

Prices of sin stocks low relative to fundamental value (15-20% lower than comparables)

Sin stocks earn higher returns after correcting for risk factors (2.5%)

Institutional investors shunning sin stocks missed out on positive returns!

THE PRICE OF SIN: THE EFFECT OF SOCIETAL NORMS ON MARKETSHong and Kacperczyk (2009)

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PERFORMANCE OF SRI STRATEGIES: PAST VERSUS FUTURE

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FUTURE (best guess disclaimer!)

• High returns on ESG standards no equililbrium effect: returns dimish as attention increases

• Sin stock effect likely to persist

PAST

SR-investors earned:

• High returns on stocks with high ESG standards

• Missed out on high returns on sin stocks

If simply overweighting high ESG firms might not work anymore (in terms of returns)…

• More focus on engagement?

• Invest in ‘rising ESG stars’?

“Performance Implications of SR-Investing” by Nadja Guenster, Chapter 23

in Socially Responsible Finance and Investing: Financial Institutions,

Corporations, Investors and Activists, Nofsinger and Baker, Kolb Series in

Finance

More SIRP research at: European Center for Corporate Engagement

(ECCE): www.corporate-engagement.com

Presentations of ECCE Conference on Finance and Responsible Business

at Haas, UC Berkeley: http://

responsiblebusiness.haas.berkeley.edu/events/2011financeandresponsible

biz.html

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