Swedroe: Costs Of Socially Responsible Investing

July 25, 2016

Socially responsible investing (SRI) aligns ethical and financial concerns for investors. SRI has gradually developed over time to include the consideration of firms’ environmental, social and governance (ESG) performance.

Of note is that, while SRI has evolved, the original practice of negative screening for the stocks of companies involved in harmful or controversial activities (so-called sin stocks) remains the most common SRI strategy today.

Pieter Jan Trinks and Bert Scholtens contribute to the literature on SRI investing with their study, “The Opportunity Cost of Negative Screening in Socially Responsible Investing,” which appears in the May 2015 issue of the Journal of Business Ethics.

The authors employed a comparative analysis on 14 potentially controversial issues over the period 1991 through 2012. In contrast to most other studies, they did not rely on broad industry classification, discarding complete industries.

Instead, they checked the 14 issues at the level of the individual firm, investigating more than 1,600 stocks (about 7% of the global investment universe, and an even higher 12% of the U.S. equity universe).

Their sample population consisted of firms in developed and emerging markets across the world (30% from North America, 28% from Asia, 27% from Europe, 7% from Australasia, 5% from South America and 3% from Africa). It appears that most controversial stocks are from the United States (23%), Australia and Japan (7%), and Canada, India and China (5%). Returns were value-weighted.

The issues the authors analyzed in their study were abortion/abortifacients, adult entertainment, alcohol, animal testing, contraceptives, controversial weapons, fur, gambling, genetic engineering, meat, nuclear power, pork, (embryonic) stem cells and tobacco.

Some of these issues are highly prevalent reasons for exclusion in socially responsible investing (alcohol, weapons, gambling, tobacco, adult entertainment, for instance); others are less well-established and institutionalized. The authors, however, noted that all the issues they evaluated “are being used in private mandates of investors, and the number of controversies seems to increase.”

Following is a summary of their findings:

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