The Best Opponent:Social Investing and Its Critics

Lloyd KurtzNelson Capital Management24 February 2005

The best athletewants his opponent at his best.

The best generalenters the mind of his enemy.

The best businessmanserves the common good.

The best leaderfollows the will of the people.

-Lao Tzu, Tao Te Ching

Topics

Definitions Normative vs. Positive

Normative Perspectives Positive Perspectives

Conclusion: The Best Opponent

Definitions

Definitions Critics argue that social responsibility is ill-defined

Hawken, The Economist, and Fortune make this point. (What isn’t?)

“Socially Responsible Investing” (SRI) Can Mean The general practice of screening portfolios Investing w/ the “Progressive Consensus” Other Paradigms

Catholic (Diocesan vs. Orders) Conservative Christian Moslem Environmental

Community Investment, Microlending, etc.

Definitions (cont’d) “Progressive Consensus” Exclusions

‘Sin Stocks’: alcohol, tobacco, gambling, firearms, pornography Involvement in weapons manufacturing Involvement in Nuclear Power Major product safety, employee relations, or environmental issues.

Problematic Issues Sweatshops Antitrust

Social Screening Policies Available at: www.calvert.com www.domini.com www.kld.com

Normative vs. Positive

Levels of the Debate Normative – “How Things Ought to Be”

Values-Driven Political Ethical Religious “SRI is misguided.”

Positive – “How Things Work” Fact-Driven Financial Economic Demographic “Here is evidence that SRI underperforms.”

Milton Friedman Illustration

Books Normative - Free to Choose Positive - A Monetary History of the United States

Quotes Normative: “The social responsibility of business

is to make money.” Positive: “In most cases [social] investing is

neither helpful nor harmful.”

Normative and Positive Commentators

Normative Positive

Supportive of SRI

Nat’l Conf of Bishops (1986)Peter CamejoPietra Rivoli (2003)

Meir Statman (2000)Marc Orlitzky (2003)Rob Bauer (2002)

Skeptical of SRI

Jon EntinePaul HawkenMark Schwartz (2003)

Chris Geczy (2003)Arthur Laffer (2004)Jeffrey Teper (1992)

Normative Perspectives

A Proponent’s View

“Although all members of the Church are economic actors every day of their individual lives, they also play an economic role united together as Church. On the parish and diocesan level, through its agencies and institutions, the Church employs many people; it has investments; it has extensive properties for worship and mission. All the moral principles that govern the just operation of any economic endeavor apply to the Church and its agencies and institutions, indeed the Church should be exemplary.”

- National Conference of Catholic Bishops, 1986 Pastoral Letter

Entine’s Critique Entine believes social investing as currently practiced is

contradictory and hypocritical. “Merely hypocritically, anti-alcohol screens ban liberal

oenophiles from investing in California wineries.” “More troubling, defense firms--those developing

missiles to protect Tel Aviv and San Francisco from Scud missile attacks--are rejected as warmongers.”

“And while some funds screened out Enron Corp. on the principle that all energy firms are "bad," its limp commitment to renewable energy and its now infamous ethical-sounding Code of Conduct made it a favorite among the largest firms like Domini Social Investments.”

Entine’s Critique (edited)

Alcohol companies will be screened out, even though many social investors drink.

Manufacturers of weapons are excluded, even though many people think weapons are ok.

Domini owned Enron.

Schwartz’s Critique

Schwartz (2003) believes that the ethics of the social investment industry need scrutiny.

Calling yourself ethical imposes a higher ethical duty. Some industry advertising is vague or misleading. Some of the screens are not ‘ethical’ (e.g., Military). The industry’s screening is not transparent. See Rivoli’s (2003) response.

The Starfish Story

Source: Domini Social Investments website, 2005

Hawken’s Critique Hawken argues social investing as currently practiced is

insufficient. “The cumulative investment portfolio of the combined

SRI mutual funds is virtually no different than the combined portfolio of conventional mutual funds.”

“The environmental screens used by portfolio managers are loose and do little to help the environment.”

“Few SRI mutual funds engage in shareholder advocacy or sponsor activist shareholder resolutions.”

Dixon’s Critique

Dixon (2004) believes change needs to be faster. Despite social investors’ efforts there are still no

sustainable companies. SRI also doesn’t do enough to address the systemic

obstacles to change. Assessments of corporate responsibility should include

companies’ efforts to create systemic change, not just “incremental leaders.”

Positive Perspectives

The LiteratureNumbers in parentheses show # of Moskowitz Prizes and Honorable Mentions.

Financial Academics (5)Journal of Finance

Working Papers

Financial Practitioners (2)Financial Analysts Journal

Journal of Investing

Management Researchers (4) Academy of Management Journal

Journal of Business

Independent Organizations (1)World Resource InstituteEnv. Protection Agency

EconomistsAmerican Economic Review

The Economic Journal

Research FirmsInnovest, IRRC,

Inst. Shareholder Services

What About Performance?

"When we here at Morningstar have conducted performance studies of socially responsible funds in the past, we've found that the offerings - as a group - perform about as well as funds that pay no attention to ethical considerations when building their portfolios.” - Hall (2004)

Bauer et al (2002) find no performance issues for mutual funds.

DiBartolomeo and Kurtz (1999) find no performance issue with the Domini Social Index.

Positive Tests of SRI

Social screens might interfere with active management strategies. Abramson (1998) finds no problem for value managers. Kurtz (1997) finds no problem for growth managers.

Social responsibility and financial performance. Orlitzky (2003) finds positive association. Laffer (2004) finds no relationship or a small negative one.

Claimed Alpha is Very Issue-Dependent Areas Associated with Outperformance

Environment Derwall et al (2004) claim positive impact

100 Best Companies to Work For Kurtz and Luck (2003) claim positive impact

R&D Many studies show positive benefit

Areas Associated with Underperformance Unionization

Blachflower (1991) claimes negative financial effects

Conclusion

The Best Opponent

Financially sophisticated Principled, but not dogmatic Unburdened by a personal agenda Presents evidence, expects the same of you Seeking to persuade, open to persuasion Engagement is transformative

Further Information

Online bibliography of SRI: http://www.sristudies.org

My SRI blog: http://srinotes.blogspot.com

My e-mail: lklyk@pacbell.net

Notes Abramson, Lorne, and Dan Chung. "Socially Responsible Investing: Viable for Value Investors?" Journal of

Investing, Fall 2000. Bauer, Rob, Kees Koedijk, and Roger Otten. "International Evidence on Ethical Mutual Fund Performance and

Investment Style." Working Paper, January 2002. Blanchflower, David, Neil Millward, and Andrew Oswald. "Unionism and Employment Behavior." The Economic

Journal, July 1991. Derwall, Jeroen, Nadja Gunster, Rob Bauer, and Kees Koedijk. "The Eco-Efficiency Premium Puzzle." Erasmus

University Working Paper, May 2004. Dixon, Frank. “Adapting to the Age of Truth: Addressing Systemic Barriers.” SRI in the Rockies Conference,

October 2004. Economic Justice For All: A Pastoral Letter on Catholic Teaching and the U.S. Economy. National Conference of

Catholic Bishops, 1986. Geczy, Christopher C., Robert F. Stambaugh, and David Levin. "Investing in Socially Responsible Mutual Funds."

Wharton School, Working Paper, May 2003. Hall, Emily. "Evaluating Socially Responsible Funds." www.morningstar.com, July 7, 2004. Kurtz, Lloyd and Chris Luck. "An Attribution Analysis of the 100 Best Companies to Work for in America.“

Presentation to Northfield Investment Conference, Fish Camp, California, May 5-7, 2002. Kurtz, Lloyd. "The Impact of Social Screening on Growth-Oriented Investment Strategies," The Journal of

Performance Measurement, Spring 1997. Laffer, Arthur B., Andrew Coors, and Wayne Winegarden. "Does Corporate Social Responsibility Enhance

Business Profitability?" Laffer Associates, 2004. Orlitzky, Marc, Frank L. Schmidt, and Sara L. Rynes. "Corporate social and financial performance: A meta-

analysis." Organization Studies, 24, 2003. Rivoli, Pietra. “Making a Difference or Making a Statement? Finance Research and Socially Responsible

Investment.” Business Ethics Quarterly, July 2003. Schwartz, Mark. "The 'Ethics' of Ethical Investing." Journal of Business Ethics, March 2003. Statman, Meir. "Socially Responsible Mutual Funds," Financial Analysts Journal, May/June 2000. Teper, Jeffrey. "Evaluating the Cost of Socially Responsible Investing," in Kinder, Peter, Steven Lydenberg, and

Amy Domini, ed., The Social Investment Almanac, New York: Henry Holt, 1992.