The finding of positive alpha for the TMB factor, however, is a puzzle for the same reason that the negative alpha for AMS should be expected. If enough SRI investors shun stocks with low TMB scores, the cost of capital of such companies will rise, and so will their expected returns. Hence the apparent anomaly.
A possible explanation is that perhaps the alpha could be explained by exposure to another factor (such as quality or low beta) not included in the four-factor model (beta, size, value and momentum).
Other explanations can be found in the behavioral finance literature. For example, the 2011 study from Alex Edmans, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices,” found that stocks of companies with highly satisfied employees earned higher returns than other stocks.
The 2005 study, “The Eco-Efficiency Premium Puzzle,” by Jeroen Derwall, Nadja Guenster, Rob Bauer and Kees Koedijk, found that stocks of companies with good environmental records earned higher returns than other stocks.
And the 2007 study by Alexander Kempf and Peer Osthoff, “The Effect of Socially Responsible Investing on Portfolio Performance,” found that stocks of companies that ranked high overall on community, diversity, employee relations, environment, human rights and products did better than stocks that ranked low on those measures. In each case, higher returns could result from investor myopia—they tend to focus on possible negative short-term costs (such as higher wages) and underestimate long-term benefits.
One final comment: Investors may be aware that there are trade-offs between wants, and some are willing to trade the utilitarian benefit of higher expected returns for the expressive and emotional benefits of avoiding the stocks of shunned companies.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.