Sustainable stock indices and long-term portfolio decisions

Abstract

What is the long-term behaviour of sustainable stock index returns and the accretive benefits to portfolio diversification? We consider these issues through the prism of a long-term investor by replicating the risk and reward behaviour of sustainable stock indices from 1927 through 2010. We find that these indices exhibit long-term mean, variance and tail-risk characteristics that are commensurate with conventional U.S. stocks. We also reveal that recent performance appears worse than their performance over the long term. On the question of portfolio diversification, we find that only one of the three sustainable stock indices investigated dominates the efficient frontier. Our findings suggest that the stock screening process of these indices has important implications regarding the desirability of these investments for long-term investors.

Keywords:

• socially responsible investments (SRI)
• sustainability
• asset pricing
• portfolio analysis

Acknowledgement

The authors gratefully acknowledge the support from the Griffith Business School New Research Initiatives Program (NRIP) in Superannuation and Funds Management. The authors are responsible for all errors.

Notes

Other studies including Lee and Faff (2009) and Lee, Faff, and Langfield-Smith (2009) examine the Dow Jones Sustainability Indexes Group by employing the Carhart (1997) multifactor model and include additional risk factors to include industry and country momentum risk factors. These studies incorporate these additional momentum risk factors as their study examines companies at the firm level and are able to construct these industry and country momentum effects.

The Fama and French (1992, 1993) Rm, SMB and HML risk factors and Carhart (1997) momentum risk factor are well recognized in the finance literature as the most important risk factors in explaining the variation in U.S. stock returns.

We gratefully acknowledge the resources of the Professor Kenneth French data library at: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

CVaR is also referred to as expected shortfall (ES) and expected tail loss (ETL) in various studies in the finance literature.