Measuring the under-diversification of socially responsible investments

ABSTRACT

This article proposes a straightforward measure of the residual unsystematic risk that a selective portfolio investment strategy, such as socially responsible investment, eventually bears. The model is empirically employed in order to analyse whether the MSCI socially responsible indices bear significant levels of volatility that could be diversified by not imposing social screenings to the set of eligible investments. The study finds that a low but not negligible part of the volatility of the returns could be diversified by not restricting the investment to socially responsible companies. Implications for the socially responsible investing industry and socially responsible investors are discussed.

KEYWORDS:

• Socially responsible investing
• SRI
• environmental social governance
• portfolio diversification
• unsystematic risk
• idiosyncratic risk

JEL CLASSIFICATION:

• G11
• M14

Acknowledgements

I have received helpful comments and suggestions from Maurizio Fanni, Cara M. Marshall, Elisabetta Venezia, Mariantonietta Intonti, Valeria Roncone, Francesco Calò, and two anonymous referees. I am very grateful to them all. I thank Antonio Cassano for his patience gathering the data. All remaining errors are my own.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ US-SIF (2014) Report on sustainable, responsible and impact investing trends in the United States (US) stated that the number of funds in the US incorporating environmental, social and governance criteria rose from 493 in 2010 to 925 in 2014. In the same period, their total net assets rose from US$569 billion to US$4,306 billion.

² MSCI has developed a methodology designed to rate companies according to environmental, social and governance criteria, risks and best practices. Companies are systematically and continually monitored. Ratings are between AAA (top) and CCC (bottom). Detailed information on these indices and on the ESG methodology is freely available from the MSCI website www.msci.com.

³ MSCI does not provide an All Cap index for the emerging markets. Thus, for this MSCI SRI index, no such comparison has been made. Clearly, the parent index for the MSCI UK IMI SRI index is the MSCI UK IMI index and not the MSCI UK index.

⁴ There were no missing values. To check for possible coding errors, Cook’s (1977) distance was used with a threshold value of 95% of the F distribution with (p + 1) and (n − p − 1) degrees of freedom. All outliers and all daily returns higher than 10% were checked for reliability by comparing the data with the official ones provided by MSCI on its official website www.msci.com. No coding errors were detected.

⁵ For instance for the MSCI US SRI index, the maximum percentage of UR that would have been borne over a 60-day observation is 3.32% if measured with reference to the standard MSCI US. This value drops to 1.90 if the investment horizon is 500 days. Greater reduction in the maximum percentage of UR is generally observable for the other indices.

⁶ The MSCI UK SRI index was launched earlier than the MSCI UK IMI index. Thus, values reported in Table 3 for these indices are not comparable as they are measured for different periods. In any case, when restricting the analysis for the MSCI UK SRI index to the same period as for the MSCI UK IMI index (4 September 2014 to 31 December 2015), the difference in the values remains, albeit lower. Indeed, the mean UR and the % mean UR for the MSCI UK index measured for the restricted period are in the 60-day analysis, 0.0059 (4.05%), 0.0051 (3.5%) and 0.0051 (3.5%), respectively, for the Standard, IMI and All Cap indices; in the 250-day analysis, 0.0054 (3.24%), 0.0046 (2.76%) and 0.0046 (2.76%), respectively, for the Standard, IMI and All Cap indices.