May 09, 2005

An Exchange

Dear Sir,

I read your entry “Nice update on the performance debate” in your SRI blog. One comment to your reasoning for why there will never be a final answer to whether SRI outperforms the overall market:

Isn't there a possibility that as we speak (or some time in the future) when investors observe the potential gain from investing in social responsible firms they will invest to the degree where the social responsible firms only generate an average profit.

I would draw the comparison to the diminishing "January-effect" we've seen in financial markets lately. Could investors learn about the SRI effect the same way, and in turn, make future SRI-studies show no superprofit for social responsible firms?

Vegard Vik

Student, Norwegian School of Economics and Business Adm.


Hi there, I personally believe that the effect you suggest has already happened to some degree. If there were a consistent, reliable SRI effect, it would almost certainly attract the attention of investors. With large mutual funds and even SRI hedge funds out there, it's hard to argue that no one in markets is paying attention to this possibility. There is a little hard evidence that investors are bidding up socially responsible stocks. If you look at Marc Orlitzky's study, you'll see that social responsibility correlated more strongly with accounting-based measures of performance than with market-based measures. That strongly implies that the market is already discounting some of the benefit of social responsibility by corporations. Dowell, Hart and Yeung also show evidence that environmental policies are incorporated into the structure of global price/book ratios. If that's right, it means the market is already bidding up stocks likely to have superior environmental performance. Investors buying those stocks at higher valuations, anticipating an environmental return, may be disappointed. One final thought. 15 years ago, when we started the Domini Social Index, I ran an analysis showing that its P/E was attractive relative to its reinvestment rate when compared with the S&P (you can find the math in Chapter #25 of The Social Investment Almanac). If you repeat that same analysis today, the Domini Social Index does not have the same advantage. So the idea that there was a positive effect, but investors have caught on to it, is not unfounded. Hope that's helpful. - LK


Blogger Jeff MacDonagh said...

I generally agree on the lack of a consistent market inefficiency based on quantitative data. Although The Barclays KLD Select ETF is banking on this SRI-driven alpha!

But I wonder if the "better management" theory of social investing can even be measured consistently? Unfortunately, SRI research is mostly backward looking, so this would be one limitation to conducting a study using this data.

Perhaps one anectodal way of seeing this theory in practice would be looking at the performance effect of major shifts in SRI investments. I'm thinking of pharma as a classic example here. But clouding this issue is SRI investors adopting some degree of a "best in class" approach, which has limited the number of portfolios that have gone wholesale out of non-exclusionary industries.

Anyhow, my point in a round-about way, is that there still could be an SRI advantage, but circumstances have made it much more difficult to discern what it might be.

5:59 AM  

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