The Cost of Being Good

Article excerpt


This paper examines the performance of U.S. equities through the use of socially responsible investment screens. Socially responsible investing (SRI) is reflected in the attitudes of the investor to apply social goals to their investment portfolio. We extend the SRI literature by examining a broader study of social screens in a more restrictive context. The sample used in Sauer (1997), based on the Domini Social Index, is "selected to minimize the potential negative side effects." In contrast, our initial approach is to examine the costs and benefits from the most extreme approach of socially responsible investing--the exclusion of companies not meeting a social investment screen. The exclusionary approach results in portfolios that maximize the costs to socially responsible investing. We examine the returns and risk-adjusted returns to investing in socially responsible investment portfolios using 20 social screens from KLD Research & Analytics, Inc. (KLD).

We extend the literature by uniquely examining the persistence in performance of SRI screens, using both Jensen's alpha and conditional alphas. Our results support the null hypothesis of no cost to investing in a socially responsible manner, or reject the hypothesis that SRI comes at a significant cost. Through either single or multiple screens based on value or equally weighted portfolios, we find no statistical significant difference among SRI screen funds. While the differences in portfolio returns are statistically insignificant, the equal-weighted "AL2SNX portfolio" of no exclusionary screened firms and only firms with at least two strengths is the best performer over the period from 1991-2004.

Literature Review

Previous literature has examined screens and socially responsible investing in both equity and bonds. Angel and Rivoli (1997) find that the reluctance of investors to invest in certain firms can lead to increases in the firm's cost of equity; however, the percentage of investors unwilling to invest has to be relatively large for the effect to be significant. Feldman, Soyka, and Ameer (1997) analyze the impact of the firm's environmental management system on stock prices, and find that improvements result, primarily, from a decrease in risk.

Research in the area of investing has led to inconclusive results. Kurtz (1997) finds that the universe of SRI stocks does not appear to underperform the market, but there are costs to diversification and information effects. Guerard (1997) finds that returns for a socially screened universe do not differ from the unscreened universe, but using multiple screens improves results. Statman (2000) finds that the Domini Social Index outperforms the S & P 500, and that socially responsible mutual funds do better than conventional funds, but the results are not statistically significant. Finally, Derwall and Koedijk (2005) find positive, but insignificant, differences between the performance of SRI funds and conventional funds, and evidence of time-variation in performance over business cycles.


There are a number of ways to approach social investment screens. It is evident from the mutual funds available that some combination or variation of three approaches is taken--divest from or exclude firms that are inconsistent with the investor's social goals; reduce or underweight exposure to such firms; or take on active shareholder initiatives to change the actions of a firm. In an asset pricing context, we examine the first or most restrictive approach, which is to test the impact of exclusions on investment portfolios. Exclusionary screens imply that an investor is either fully in favor of or against a particular social screen or issue. A firm must pass a particular screen for an investor to include it in his or her portfolio. One way of interpreting such an investment policy in an optimization framework is that there is an infinite cost attached to the exclusionary belief. …