Monday, August 08, 2005

Socially Responsible Investors

I hate it when the WSJ "scoops" me, but that is where I found out about this paper. It is by Bollen and Cohen.

Socially Responsible Investing has been studied a great deal. Most of the work has looks at whether investors receive lower returns as a result of the SR criteria. Financial theory suggests that the more constraints placed on a portfolio, the lower the returns should be. (To put it another way, the addition of a constraint should make investors worse off when measure by risk and return). Somewhat surprisingly, the research on this has been very mixed.

Bollen and Cohen might have a partial explanation. They examine the behavior of SR investors. The results? SR investors appear to be more patient. This trait reduces transactions and (if theory is correct) should increase returns.

From the paper:

"following negative returns, cash outflows from SR funds are indeed smaller than cash outflows from a matched set of conventional funds, suggesting that investors derive utility from the SR attribute. Following positive returns, however, cash inflows to SR mutual unds are larger than cash inflows to conventional funds. An explanation for this asymmetry is that SR investors perceive the SR attribute as a luxury good which is more affordable when their level of wealth is sufficient."

Two quick points:

1. It is possible that the reason previous researchers have not been able to find a SRI penalty is that the lower returns due to the self-imposed constraint is offset by the higher net returns stemming from lower transaction costs and greater planning horizon provided by the higher cash flow predictability.

2. That SRI is seen as a luxury good is a cool finding. If pushed this is consistent with the view that improving economies could be expected to improve the same aspects that SRI investors are concerned with. (for instance firms in trouble worry less about the environment than firms "doing well").


Bollen and Cohen, Working paper, Vanderbilt University. Downloaded 8/8/05

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