Advocates of SRI investing contend that there is no tradeoff between ethical investing and investment performance. Quite the contrary, they argue that companies run according to ESG criteria enjoy certain advantages over ones that are not. These should, so the theory, make them stronger companies and hence better investments over the long term.
Others maintain the opposite. Based on the findings of portfolio theory, they say the SRI selection process should detract from performance. Restricting the universe of possible investments, for instance, reduces diversification benefits. The extra cost associated with SRI portfolio selection potentially eats away at returns.
So which is it? The evidence is not yet conclusive, though there are indications.
A report by the Stockholm School of Economics (SSE) examining more than 20 peer-reviewed studies of SRI performance found no obvious connection between SRI and return differentials in 65% of the cases. Only 14% of the studies reported lower reported risk-adjusted returns, while 24% revealed positive correlations. Researchers also found that the costs of managing SRI funds were not higher than those for managing regular funds.
To find out more, we recently carried out some research at UBS comparing the makeup and performance of MSCI SRI indices against their parents.
We found that the SRI indices generally preserved the diversification characteristics of the parent (although more so on a global than a regional level). We also found that MSCI's major SRI indices have all outperformed their parents in risk-adjusted terms, net of fees – despite the fact that these companies generally had lower trailing earnings than their peers.
According to this data, passive SRI investing using these indices does not result in reduced diversification. It also generally translates into higher returns – as investors seem willing to pay a premium for the positive social tilt achieved with the SRI approach.
While the verdict is still out, SRI investors can take comfort in the numbers so far. The SRI investment case, it would seem, is solid.