Stockholm (NordSIP) – A new joint study by researchers from the University of Rome and the University of Groningen has found that investors ‘pay a price’ for SRI holdings. “The Price of Taste for Socially Responsible Investment”, which was published in June by the Centre for Economic and International Studies and which analysed 1,000 firms globally between 2005 and 2014, found evidence that investor preference for SRI led to an underperformance of a considerable 4.8% annually.
“With respect to the taste effect, investors seem to pay a price in terms of lower returns due to their preference for SRI. The premium related to the responsibility score, the price of taste, is negative, significant and stable across all model specifications,” the paper’s authors Rocco Ciciretti, Amrogio Dalo and Lammertjan Dam wrote.
In addition, the authors suggest the trend towards SRI is explained either by SRI assets having better risk characteristics or investor desire for other reasons. The study controls for risk characteristics that attract or repel SRI investors to get a better view of the impact of SRI stock preferences has on returns.
First, the study identifies which firms score best on a range of factors from corporate governance and community involvement to environmental stewardship. Adjusting these firms for risk, it then evaluates how portfolios comprised of these companies scored on SRI criteria on an ascending basis.
The study found that as pro-social behaviour in companies rises, stock market outcomes decline, with similar results on the individual company level as on a portfolio basis. There are limitations to the methodology employed in the study, however, writes Reuters columnist James Saft. For one, it does not provide a ‘pure’ view of the impact of SRI.
For example, criteria used to screen the SRI performance of companies have different objectives: corporate governance protects the rights of shareholders from insider trading, while environmental criteria sets value to climate change and other considerations. The time period evaluated may also be subject to discrepancy given the era of monetary policy following the global financial crisis in 2008.
In addition, investors may consider the success of SRI investment across more criteria than strictly financial returns. Also, individual investors will often have different motivations and calculations than institutional investors, the latter, such as pension funds, acting on behalf of larger groups of people.
The paper’s abstract reads as follows:
The demand for socially responsible investment (SRI) might be driven by:
- i) the risk characteristics of “responsible” assets, and/or
- ii) investors’ taste for such assets.
The former driver positions SRI in the conventional risk-return framework, the latter entails that investors screen stocks out of their portfolios based purely on their taste for such assets, uncorrelated to risk and return considerations. Theoretically, the screening of certain assets based on investors’ taste should lead to a return premium on the screened assets in equilibrium. In this paper, we disentangle the different contributions of risk and taste in generating risk-adjusted returns for socially responsible assets. By ruling out both systematic and residual risk components, we try to quantify whether and to what extent investors pay a price, in terms of lower returns, due to their taste for responsible assets. Using a sample of 1000 firms from the U.S., Europe, and Asia, between 2005 and 2014, we find evidence for the taste effect and estimate the associated under performance at 4.8% annually. Our results are robust against different model specifications and test assets.
Read the paper here.
Image: (c) Fotolia