Do socially responsible investment indexes outperform conventional indexes?

Abstract

The question of whether more Socially Responsible (SR) firms outperform or underperform other conventional firms has been debated in the economic literature. In this study, using the Socially Responsible Investment (SRI) indexes and conventional stock indexes in the US, the UK and Japan, first and second moments of firm performance distributions are estimated based on the Markov Switching (MS) model. We find two distinct regimes (bear and bull) in the SRI markets as well as the stock markets for all the three countries. These regimes occur with the same timing in both types of market. No statistical difference in means and volatilities generated from the SRI indexes and conventional indexes in either region was found. Furthermore, we find strong comovements between the two indexes in both the regimes.

Keywords:

• socially responsible investments
• Markov switching model
• maximum likelihood estimations
• return and volatilities
• bear and bull market

JEL Classification:

• Q56
• G15
• Q01

Acknowledgements

The authors thank Manijeh Schwindt and the anonymous referees for helpful comments. We also thank participants at the Fourth World Congress of Environmental and Resource Economists. This research was funded by the Ministry of Environment and a Grant-in-Aid for Scientific Research from the Japanese Ministry of Education, Culture, Sports, Science and Technology (MEXT), the Japan Securities Scholarship Foundation, and the Japanese Bankers Association. The results and conclusions of this article do not necessarily represent the views of the funding agencies.

Notes

¹ See, for example, discussions in McWilliams et al. (2006).

² The smoothed probability is a probability of each regime at any given time evaluated using the estimated model and all observed data.

³ Note that Pr(s_t  = 1|ψ_{t− 1}) + Pr(s_t  = 2|ψ_{t− 1}) = 1. Once we are able to calculate Pr(s_t  = 1|ψ_{t− 1}), it is very easy to obtain Pr(s_t  = 2|ψ_{t− 1}).

⁴ Our analysis comprehensively compares indexes considering heterogeneous regulations and the various meanings of SRI. In addition, our approach might include a critique in which we do not compare ‘apples to apples’ or ‘oranges to oranges’ by comparing the performance of socially responsible stocks to those that are not socially responsible within the same industry. This is because conventional strategy indexes include stocks from multiple stocks from multiple sectors of the economy, whereas SRI indexes may not favor stocks from a particular sector such as tobacco or alcohol. However, the decision that a particular industry is excluded from the SRI basket of industries is also a criteria of SRI itself and, therefore, is a key element of SRI characteristics. Furthermore, the list of firm changes over time and the list of SRI index firms are available for all study periods in all the three countries. Finally, whether the SRI indexes outperform conventional indexes is also an important question. Therefore, we focus our analysis on comparing the indexes.