Socially Responsible Investment. ECG Factors

Table of content

I. Introduction

II. What is socially responsible Investment?
A. Terminology
B. History
C. Strategies
1. Negative Screening
2. Shareholder Activism
3. Positive Investing
4. Impact Investing

III. Relative performance of SRI portfolios

IV. Deduction

V. Appendix

I Introduction

Investors talk about increasing profits, minimising transaction costs or how to evade taxes most effectively, but very few investors consider about, if the company contributes something to society, treats employees with respect or tries to reduce harm to environment in fact - they do not invest socially responsible.

- But what is socially responsible and how can firms be obtained which make the grade?

In the following, this essay provides a short overview about the history of Socially Responsible Investing (SRI) and its terminology. Furthermore, different investment strategies are explained in order to understand the depth and the variety of possibilities using these strategies.

Knowing these facts, the main reason for investors to invest lies within the nature of things: the return. Every good intention will be flood by the opposite, if the good intention does not perform well and the sinner stocks achieve excess returns. The overall opinion about SRI and the most common theory is that the SRI approach is underperforming the market, as the investor is restricted in stock selection, which decreases the possible level of diversification eventually leading to a lower risk-return level.

- But do SRI portfolios underperform the market, respectively the “Sin Stocks”?

Moreover, this paper tries to use statistical approaches to approve or disapprove the above- mentioned theory. By regressing the returns of the biggest social index, the KLD 400, against the returns of the S&P500 and the biggest Sin Stocks Fund, called VICEX, an informed choice will be possible. Furthermore, the investment approaches will be analysed in the overall context of their long-term performance and possible explanations for under- & overperformance.

In addition, this essays appendix provides an approach of investing, fulfilling the criteria of SRI and the ESGs, which stands for environmental, social and corporate governance criteria. This project deals with the increasing amount of refugees coming to Germany and the consequent lack of real estate supply. This lack of supply causes difficulties regarding the integration process, which will eventually lead to a separation of the community and increasing appeal of right wing populists.

II What is socially responsible investing (SRI)?

A Terminology

The acronym SRI is used to describe an investment strategy which seeks to combine financial return and social benefit in order to manage an overall social change. The terminology itself differs somewhat as responsible investment, socially responsible investing, sustainable investing, ESG investing and green investing can be aggregated to SRI.^{[1] [2]}

In general, socially responsible investors encourage corporate practices that promote environmental stewardship, consumer protection, human rights, and diversity. Some avoid businesses involved in alcohol, tobacco, fast food, gambling, pornography, weapons, contraception, abortifacients, abortion, fossil fuel production, and the military. In the following, the term SRI is used as a synonym for all the different investment approaches above.

B History

SRI first was used as a term in 1758 by the Religious Society of Friends in Philadelphia as a reaction to slave trade. In order to “invest” socially responsible, members were prohibited to participate on the slave trades either as buyer or as seller. Although this prohibition was very uncommon, as the deals tend to be very profitable, it was generally accepted among the members.

John Wesley, 1703-1791, was one of the earliest operators of the SRI approaches, but in a more general way than they are implemented today. His intention was to neither use money to harm fellow citizens by exerting obscure business practices nor by supporting industry sectors which could be dangerous for their employees like the chemical industry.

The progress of the approaches stopped until the 1970s, which was exactly the time of the Vietnam War.^[3] Although the equality of women was at the same time the most famous example of how social responsibility could influence the real economy which is shown on the right side.

Phan Thj Phuc, who represents the face of the Vietnam War, became famous through tragical circumstances. An U.S. photographer took this picture in Vietnam after the U.S. Army ignited a Vietnamese village by using Napalm. As Dow Chemicals was the major producer of the chemical the public reluctance against Dow Chemicals increased and pressured the company and the U.S. government.

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Furthermore, during the 1980s, the progress of SRI increased as trade unions in the U.S. began to adopt some principles into the investment strategy of their pension funds. In the beginning, they started to invest in housing projects for the labourers in order to provide them with affordable accommodations. Moreover, they started to invest in medical facilities which should provide the local society with affordable medical treatments.^[4] During the presidential elections of the 1980s the candidates more and more adopted principles of SRI into their campaign strategy and advocated the work of the trade unions done so far. The allowance of pension schemes to invest socially responsible, however, depends on achieving the risk-adjusted market-rate in terms of financial return.^[5]

Also SRI caused pressure on companies which were invested in South Africa, during the Apartheid, in which course weapons facilitators were pilloried for catalysing the upcoming civil war. As a result, companies steadily decreased their investments due to the pressure.^[6] The decreasing cash flow into South Africa was one factor which had contributed to end the Apartheid.^[7]

C Strategies

An increasing societal demand for sustainable investment practices has evolved, particularly among the millennials. This situation changed the behaviour of investing, especially for parastatal or big insurance companies which depend on the favour of society. In that course a growing number of asset owners, including pension funds, argue, it is their fiduciary duty to consider such aspects before making an investment decision. More precisely the investment decision, nowadays, is not only based on return only but on finding a balance between return and social responsibility.

Abbildung in dieser Leseprobe nicht enthalten

The market share of SRI funds is steadily increasing, especially since the early 2000s. The United Nations launched a global guideline for companies that wanted to develop into a socially responsible investment, called the Global Sustainable Development Goals. These guidelines were the first of its kind and implemented a general, international standard.

Notable is the difference between the increase in market share in different countries and continents. As Europe has always tended to invest at least an adequate proportion of capital within the rules of SRI, the U.S. started late, but had a tremendous rally to equal the differences. Asia ex Japan is the surprising exception as the overall market share is tremendously low compared to Europe and the U.S. ^[8] This is presumably due to the fact that investing socially responsible is a phenomenon of luxury and China, respectively most Asian countries have few very rich people and a general mass of poor people within their society.

The environmental, social and corporate governance criteria (ESG) are the more thorough fundamentals for monitoring and recognising a company that fits the SRI approach. The following three diagrams show the different attributes related to the acronym.

These ESG criteria are generally accepted principles for corporate governance.^[9]

Abbildung in dieser Leseprobe nicht enthalten

Negative Screening^[10]

This screening process deals with the exclusion of several investment strategies and types, which infringe the criteria of ESG. It only deals with the fact, which firms shouldn't be supported, because of their status and business model.

This categorisation contains the “Sin Stocks” which include e.g. tobacco, gambling, alcohol or environmentally harmful companies. As a matter of fact, this negative screening contributes to the mainstream opinion that SRI portfolios underperform the market, because of the constrained diversification possibilities. The studies of Lobe and Walkshausl about the empirical proof of this underperformance provided an approach that there was no underperformance at all, rather the performances need to be risk-adjusted in order to compare them.^[11]

In the course of negative screening, divestment becomes a more important issue as for example Allianz SE lately announced not to invest in coal energy, respectively companies contributing to it anymore and divesting its previous engagements.^[12]

Shareholder Activism^[13]

This stance of shareholders describes an attempt of influencing the operating management respectively the corporate behaviour by pressure. The shareholders form an interest group in order

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^[1] See Sparkes / Russell (2010).

^[2] See Ransome / Sampford (2011).

^[3] See Sparkes / Russell (2010), p. 46-48.

^[4] See Hawley / et al. (2015), p. 112-113.

^[5] See Berry (2013) (web).

^[6] See Sparkes / Russell (2010), p. 52-55.

^[7] See “Report on Sustainable and Responsible Investing Trends in the United States. US SIF: The Forum for Sustainable and Responsible Investment Is the Nonprofit Membership Association for the Responsible Investment Industry in the U.S.” (2014) (web).

^[8] See Saminather (2016) (web).

^[9] See Hebb (2016), p. 21-25.

^[10] See “Negative Screening.” (blank dated) (web),

^[11] See Walkshausl / Lobe. (2007).

^[12] See Ortmann (2015) (web).

^[13] See Copland (2014) (web).