1. Sally Hamilton, Hoje Jo and Meir Statman
"Socially responsible" investors favor certain companies over others according to criteria such
as production of weapons or use of alteTnLltive energy sources. We find that socially
responsible mutual funds do not earn statistically significant excess returns and that the
performance of such mutual funds is n.:Jt statistically different from the performance of
conventional mutual funds.
I nvestment managers that consider social responsibility minorities and the increase of worker ownership in
criteria in selecting securities for their portfolios have corporate America. Second, recognizing the human
received much attention from the financial press and price that has been paid in the workplace for much
considerable money from investors. The Social Inve~;t- industrial development, SRI promotes practices to
ment Forum reported that the value of "socially respon- humanize the work environment. These include
sible" investment portfolios had reached $600 billion as alternatives to the traditional assembly line and the
of January 1992. The TIAA-CREF Social Choice Accounlt, promotion of a clean, safe, and rewarding work
established in March 1990, had reached $273 million ;IS environment. These two goals must be achieved
of September 1992. within the context of making a profit. However,
The definition of "socially responsible" companies profit may be misused for unsafe and exploitive
varies greatly. Socially responsible investors typically purposes, and ironically, this can have a serious and
use a combination of "positive" and "negative" invest- negative economic impact. Therefore, a third goal of
ment criteria. The Calvert Social Investment Fund, for SRI involves rethinking the ways profit has been
example, does not invest in companies that have oper- traditionally used and distributed. Finally, all these
ations in South Africa, that manufacture weapons, or goals are related to a fourth goal: convincing the
that are engaged in nuclear power. The fund favors business world that a corporate conscience can
companies that are environmentally sound, have good pay. I
employee relations, good records for advancing minor-
Others, such as Rudd, question the legitimacy of
ities and good pollution-control management. The New
social responsibility criteria:
Alternatives Fund favors companies that are environ-
mentally sound, those that are engaged in work on There is one important difference between social
alternative energy sources, and those that are devoted to responsibility criteria and others. The latter are
resource recovery. Table 1 presents some additional imposed on the manager solely by the investment
examples. considerations. It is true that they may be mis-
There is no general agreement on the role of social guided, but the underlying rationale is defensible;
responsibility criteria in investment management. namely, the aim is to protect the financial condition
Lowry, a promoter of social responsibility, identified of the beneficiaries. Few of the social responsibility
criteria have this property. 2
four goals of socially responsible investing (SRI):
First, SRI involves strategies to democratize the The criteria for inclusion in a socially responsible
economy in two important ways: encouragement of fund create conflict on occasion. For example, a Wall
the hiring, retention, and promotion of women and Street Journal article reported that:
The Calvert fund --.has been debating whether to
sell its 75,000 shares of Angelica Corp, a St. Louis-
Sally Hamilton is with the Co~te Financial Planning and Analysi:;
Group of Tandem Computers Incorporated. Hoje Jo is an Assistant
based hospital-supply company. Last year Angelica
Professor of Finance at Santa Clanz University. Meir Statman i:; ran afoul of the National Labor Relations Board, and
Professor of Finance at Santa Clara Uni~ity.
last month a federal appeals court upheld an NLRB
FInarriaI AnaIysts.k>umaJ NoverTre'-DecemOOr
I 1993
62

2. T~ 1. ~ Criteriafa" Irx:Iusic(1 Exck.Jsioo COfT1D1ies ~
or of fa"
Socially Respa1siE MutlJalFurxis
MutuaIFund Criteria for Inclusion Criteria for Exclusion
Calvert-ArielAppreciation E,PC S,W,N }
Calvert SocialInvestmentFunds E, ER, PS,PC S,W,N
Domini SocialIndex Trust E,C,ER 5, W, N, A&:T, G
DreyfusThird CentUIy E, 0, EEO, PS 5, A&:T
New Alternatives E,A,R S,W,N
Pamassus Fund E, ER 5, W, N, A&:T
Pax World Fund A, PS,PC S,W,N,A&:T,G
SchieldProgressiveEnvironmentalFund E,A, PC EPA
Critem for Inclusion
E = environmentallysound
C = hassecuremarket segments strOI1g
and reputationswith customers,
competitorsand employees
PS = producessafe products
ER = has good employee relations
P = producesproducts of good quality
0 = has a good record in equalemploymentopportunity
EEO = has a good record in employmentopportunity
A = usesalternative energy sources
R = recoversreso~
CP = has significant participationin the (:ommunity
PC = contributesto the control of pollution
Criteria for Exclusion
S = has operationsin SouthAfrica
W = producesweapons
N = uses nuclear power
A& T = is part of the alcohol or tobaccoirldustries
G = is part of the gambling industry
EPA = is a violator of EPA regulations
Source: Social Investment Services, January 1, 1992.
ruling that Angelicahad wrongly refusedto bargain ond, what are the actual relative returns of socially
with a union. responsible mutual funds and conventional mutual
Calvert's trustees have delayed a decision on funds?
whether to dump the stock pending the outcomeof
labor talks that Angelica began last week under HYPOlHESES
court order. 'The companyhad a history of reason- There are three alternative hypotheses about the relative
ably good labor relationships,so we've beengiving returns of socially responsible portfolios and conven-
them the benefit of the doubt," says Lawr,ence tional portfolios. The first hypothesis is that the (risk-
Litvak, a U.S. Trust portfolio manager. Angelica adjusted) expected returns of socially responsible port-
says it is "hopeful" it can reach a "satisfa<:tory folios are equal to the (risk-adjusted) expected returns of
agreement" with its union. conventional portfolios. This is consistent with a world
But nonsocial considerations will also influ,ence where the social responsibility feature of stocks is not
the decision to sell or keep the stock. Mr. Litvak priced. In other words, socially responsible investors
says the union problem partly reflects Angelica's who sell stocks find enough conventional investors
responseto increasedcompetition in the hospital- ready to buy that the prices of the stocks do not drop.
supply business.The competitive squeeze profit
on This is the hypOthesis that is closest in spirit to the
margins also gives Mr. Litvak concern about the standard framework of finance, where factors that are
value of Angelica's stock, he saYS.3 not proxies for risk do not affect expected returns.
Becauseexpected returns to investors are also the cost of
We do not join the debate about the legitimacyof capital to the company, this hypothesis implies that
sociallyresponsibleinvesting or the relativemerits of the socially responsible investors do not reduce the relative
varied and conflicting criteria. We take the definitiol1Sof cost of capital to socially responsible companies by
favoring their stocks. '
social responsibility from their promotersand ask two
questions. First, what are the alternative hypotheses The second hypothesis is that the expected returns
about the expectedrelative returns of sociallyresponsi- of socially responsible portfolios are lower than the
ble mutual funds and conventional mutual funds? Sec- expected returns of conventional portfolios. This hy-
RnarK:iaf Analysts Journal! November-~r 1993 63

3. pothesis implies that socially responsible investors tlave outperfonned the NYSE portfolio by 0.187% per year
an impact on stock prices. In particular, they increase over the 1960-83 period. Grossmanand Sharpe also
the value of socially responsible companies relativ,~ to found that the outperformance of the South Africa-free
the value of conventional companies by driving down portfolio can be attributed entirely to the fact that
the expected returns and the cost of capital of socially companies that portfolio are smaller,on average,than
in
responsible companies. This also implies, contrary to the the NYSE companies.7
first hypothesis, that the market prices the social respoOn- The studies by Rudd and Grossmanand Sharpe
sibility characteristic. comparethe perfonnance of stocks of South Africa-free
The plan by RJR Nabisco Holding Inc., which sells companies with the perfom'lance of index portfolios.
both tobacco and food, to issue a class of stock pegged to Their analysesleave open two questions. First, social
its food business alone illustrates the point. According to responsibility criteria include issuesbeyond South Af-
Shapiro, RJR Nabisco managers believe that the com- rica; what about the perfom'lances of portfolios that
pany's market value is depressed in part because some embrace other social responsibility criteria? Second,
investors avoid tobacco stocks for moral reasons; ciga- most investorschooseactiveportfolios rather than index
rettes are linked to the deaths of 434,000 Americms funds; how do socially responsible portfolios perfOm'l
every year.4 relative to active conventionalportfolios?
The third and last hypothesis is that the expected
returns of stocks of socially responsible portfolios ,are EMPIRK:AlANALYSIS
higher than the expected returns of conventional p<Irt- Lipper Analytical Servicesprovided us with monthly
folios. This is the case of "doing well while doing goo<i." returns (including dividends) of all equity mutual funds
This might be possible if a sufficiently large number of in their data bank for the period from January 1981
investors consistently underestimate the probability that through December1990:The number of mutual funds
negative information will be released about companies identified by their managers as socially responsible
that are not socially responsible. Imagine, for example, funds increased from six in 1981to 32by the end of 1990.
that conventional investors consistently underestimate Because thesefunds are new, we divided the 32into two
the probability that oil companies will find themselves in groups-the 17establishedin 1985or earlier and there-
trouble because of oil spills. Declines in the prices of oil fore in existencefor at leastfive yearsby 1990and the 15
company stocks following oil spills will lower the J:e- that were establishedafter 1985.
turns on conventional portfolios holding oil company We measurethe excess returns of eachmutual fund
stocks, but the portfolios of socially responsible invE~S- using Jensen'salpha:8
tors who shun oil stocks will not be affected. Ri -R, = ai + .8,{R.. -R,) + ei,
To determine which of the three hypotheses is
consistent with the evidence, we turn first to a discu:s- where ~ is the monthly return on the value-weighted
sion of existing studies of the performance of socially NYSEand Rr is the monthly return on the three-month
responsible portfolios and then to our analysis of pE~r- U.S. Treasurybill.9
formance. Table 2 presents the excessreturns on the funds
established 1985or earlier. The excess
in returns of 15 of
STU~ES OF SOOALL Y RESPONSIBLE the 17funds are not statisticallydifferent from zero. One
PORTFOl.K)S mutual fund has positive and statistically significant
Most existing studies of the performance of socially excess returns and anotherhas negativeand statistically
responsible portfolios focus on portfolios that hold COD:- significantexcess returns. The average excessreturn for
panies with operations in South Africa versus portfolios the 17 socially responsible mutual funds is a loss of
without such companies. approximately6 basis points per month, or 0.76% per
Rudd compared the characteristics of the S&P 5(KJ year. The results for the mutual funds established in
1986and later are similar. to
with the characteristics of an optimized S&P 500 portf()-
lio that excluded companies with operations in South We know from many studies that, on average,
Africa.s He found that the extra market covarian<:e mutual funds trail broad stock indexes. It is therefore
induced by excluding companies with operations in possible that, while socially responsiblemutual funds
South Africa is small, resulting in an expected annual have low excessreturns relative to the NYSE, their
return only 0.037% lower then the return on the S&P returns are higher than the averageexcessreturns of
500.
conventional mutual funds. To examine the relative
Grossman and Sharpe compared the actual perfoJr- performance of socially responsiblemutual funds and
mance of the NYSE with the performance of a ValUE~ conventionalmutual funds, we constructeda conven-
weighted NYSE portfolio that excluded companies with tional mutual find benchmarkfrom the Lipper data. We
operations in South Africa. 6They created a South Africa- first excludedfrom the Lipper list all sociallyresponsible
free portfolio with risk (standard deviation) equal to the mutualfunds. We then divided the conventionalmutual
risk of the NYSE by combining the South Africa-free funds into two groups according to the fund age. The
portfolio with Treasury bills. Grossman and Sharpe first group containsall conventionalmutual funds estab-
found that the risk-adjusted South Africa-free portfolio lished in 1985 or earlier and the second contains all
FI1arK::iaIAnaIysts.bJrnaI / r..k)vember-Oecember 1993
64

4. Tci>Ie 2. Excess ~ ~1Cf1ed Usi~ Mcx"lthly
RetI.ms fa' ~ 17Socially ~1Si:>e MutI.a FLn:is
~istm in 1005 or earS'
Calvert SociallnvestmentFund 0 .0066 0.08
(0.0460)
Dreyfus Third Century Fund -0.3339 -4.01 0.8424 0.8597 1/81-12/90
(-2.1440).
EvergreenFund -0.0627 -0.75 0.9613 O.
8808 1181-12/90
(-0.3870)
GreenspringFund 0.4136 4.% 0.3523 0.5431 8/83-12/90
(2.3500).
IDS Equity Fund -0.1202 -1.44 1.0274 0.9182 6/81-12/90
( -0.8570)
New Alternatives Fund -0.1538 -1.85 0.9075 0 .8409 12/82-12/90
(-0.7670)
New EconomyFund 0.1439 1.73 0.9378 0.9193 12/83-12/90
(0.9<XXJ)
PamassusFund -0.2525 -3.03 1.1549 0.8142 1/85-12190
(-0.6600)
Pax World Fund 0.0235 0.28 0.6970 0.8528 1/81-12190
(0.1770)
Pioneer II 0 .0604 0.72 0.9710 0.9101 1/81-12/90
(0.4320)
Pioneerill -0.1265 -1.52 0.9642 0.8216 12/82-12/90
(-0.5540)
Putnam Health ServicesFund -0.1960 -,2.35 1.0532 0.7823 5/82-12/90
(-0.6960)
Putnam OTC Emerging Growth 0.2014 2.42 .2795 0.7514 12/82-12190
(0.5390)
Royce FD: Value 0.0953 1.14 0.7314 0.7570 1/83-12190
(0.4480)
S<:udder Growth &. Income -0.2537 -3.04 0.8577 0.8625 1/81-12/90
( -1.6180)
SFr Environmental Awareness -0.5274 -6.33 0.9121 0.7091 5185-12'90
(-1.2980)
TransamericaCapital Appreciation 0.4785 5.74 1.1127 0.6618 10/85-12/90
(0.8020)
Mean Excess
Return -0.0630 -0.76
.Significantly different from zero at the 5% level.
.Annualized excessreturns, i.e., monthly excess returns multiplied by U.
conventional mutual funds established in 1986 or later. of 150 conventional mutual funds established in 1986 or
Last, we constructed, by random drawing, a sample of later to serve as a benchmark for the 15 socially respon-
170 conventional mutual funds from the first group to sible mutual funds established in 1986 or later. Table 3
serve as a benchmark for the 17 socially responsible presents the estimated excess returns for all funds.
mutual funds established in 1985 or earlier and a saznple The mean excess return of the first conventional
T~ 3. A Ca~ of Moothty ~ Retun"tS Socaty Responsible
of arK1Ca~ ~ FurKis
SociallyResponsibleMutual Funds ConventionalMutual Funds t-Statistics
of the Difference
Mean Monthly Standard :Number Mean Monthly Standard Number between the
Excess Return Deviation of FundsExcessReturn Deviation of Funds Means
Funds Established1985 -o.~% 0.3298 17 -0.1402% 0.4279 170 -0.9199
or Earlier
Funds Established1986 -0.2772% 1.0592 15 -0.0416% 0.4977 150 0.8521
or later
Finaroal Analysts JoomaJ / Novemrer -Docemrer 1993 65

5. benchmark group is -0.1402% per month or 1.680/0 per willing to receivelow returns as fair exchangefor chang-
year. That mean excess return is lower than bu.t not' ing the world. But not all socially responsible investors
statistically different from the mean -0.76% per year attempt to change the world. As Domini noted:
return of the corresponding group of 17socially re:;pon- ...
sible mutual funds. The mean excess return of the Often soaally responsible Investors express the
second conventional benchmarkis -0.0416% per month impetus to manage their money under social criteria
or -0.5% per year; it is higher than but not statistically as a des~e for an "integratio~ of money into ~ne's
different from the mean excess return of -3.330/;;per self and Into the self one WIshes to become. An
year for the corresponding group of 15 socially re~ipon- institution may strive for consistency between its
sible mutual funds.iI mission and the way it achieves that mission. In
Our results indicate that the market does not price both instances, this motivation comes from within.
social responsibility characteristics.Investors can e:<pect The provost of a Quaker college was asked why his
to lose nothing by investing in socially responsible collegedid not invest in the manufaCturersof anna-
mutual funds; social responsibility factorshave no effect ments. Did the board of trustees think it was going
on expected stock returns or companies' cost of capital. to stop the annaments buildup? "No," he re-
Our results might disappoint socially responsibleirlves- sponded, "our board isn't out to change the world.
tors who hope to do well while doing good. They nught We're seekinga onenessbetween ourselvesand our
also disappoint socially responsible investors who are Lord."u
FOOTNOTES
1. R. Lowry, GoodMoney: A Guide to Profitable SocialInvesting in rity market line is flatter than assumed by <Rm-rJ,
the 90s (New York: W. W. Norton & Company, 1991),p. 56. estimates of Jensen'salpha tend to be negative for high-
2. A. Rudd, "Social Responsibility and Portfolio Perfor- beta portfolios and positive for low-beta portfolios (seeN.
mance," G2lifomia Managemrnt Review 23 (1981), 55-6]. Chopra,J. Lakonishokand J. Ritter, "Measuring Abnormal
3. E. Lee, "It's All Relative: Mutual Funds Discover 'SO<jally Performance: Do Stocks Over-react?" journal of Financial
Responsible' is in Eye of Beholder:' Wall Street Journal, May Economics (1992),235-68).Our use of the value-weighted
31
20,1987. NYSE index makes this problem less severe than if an
4. E. Shapiro, "RJR Nabisco May Issue Separate Class of
equally weighted NYSE index were used.
Stocks Tied to Firm's Food Business," Wall Street Journal,
10. The Upper list contains "live" mutual funds, funds in
February 1, 1993.
existence at the time the list was compiled. It does not
5. A. Rudd, "Divestment of South African Equities: How
include mutual funds that existed dwing a portion of the
Risky?" Journal of Portfolio Management, Fall 1979.
sampleperiod but went out of existenceby the time the list
6. B. Grossman and W. Sharpe, "Financial Implications of
was compiled. Because funds that go out of existencetend
South African Divestment," Financial Analysts Journal,July!
to be poor performers, our data are possibly subject to
August 1986.
survivorship bias.
7. A brief report of an analysis of the performance of 12
11. The substantial inflow of money into socially responsible
sodally responsible mutual funds and money managers is
portfolios during our 1981-90 sample period may have
provided in J. A. Tepper, 'The Cost of Social Critel1a,"
inflated the returns of socially responsiblemutual funds. If
Pensions & Investments, May 13, 1991. He finds (p. 34) that
so, these returns might be lower in the future than they
"the social managers underperformed in five of the six
years. ..and had a risk-adjusted annual cost of 1.9%."
were in the 1980s.
8. M. Jensen, 'The Performance of Mutual Funds in the
12. A. Domini, "What is Social Investing? Who are SodaI
Period 1945-1964," Journal of Finance 23 (1968), 389-41.5.
Investors?" in Kinder, Lydenberg and Domini, eds., The
SocialInvestmentAlmanac (New York: Henry Holt and
9. Jensen's alpha is a good measure of investment perlor-
mance (see M. Grinblatt and S. Titman, "Do Benchm;lrks Company, 1992),pp. 5-7.
Matter? A Study of Mutual Fund Returns" (Working paper, We thank Melanie Austin, Edward Chow, RogerHuang
UCLA, 1991» and the bias due to timing is likely to be SJnall and Jay Ritter for their helpful comments, the Leavey
(see M. Grinblatt and S. Titman, "Portfolio Performance School of Businessat Santa Oara University for research
Evaluation: Old Issues and New Insights," Reviewof Finan- support, and Michael Upper and John Feeley of Upper
cial Studies 2 (1989), 393-416). Because the empirical 5'~- Analytical Servicesfor mutual fund data.
Rnarx:iaI Analysts ..kJurr1a!November-December 1993
/
00