Socially responsible investing, according to wikipedia, “describes an investment strategy which seeks to maximize both financial returns and social good.” This typically includes not investing in tobacco, breweries, defence contractors, gaming companies, those with poor environmental records or operations in countries known for human rights abuses and so on. There are clear similarities with many of the requirements of Sharia’ investing.
The first interesting thing about this definition is that maximising two criteria is only very rarely possible. With two criteria there is usually a trade-off and one needs an objective function to determine the optimal combination of the two. I sometimes wonder whether it’s not often the case that the maximum social good would come from the donation of 100% of the invested capital.
Some proponents of Socially Responsible Investing (SRI) claim that by investing in companies that are good for society, one will also be maximising financial returns. This is only possible if the solutions to each individual maximisation problem are the same. If this were true (fine print: and there is a unique solution) then seeking to maximise financial returns will provide the same solution as maximising social good. Put this way, it seems unlikely.
There are others who posit the easier propostion that we should invest in a socially responsible manner because it is the right thing to do. This is a normative statement based on a particular value judgement and cannot be assessed without assessing the value judgement. Simply put, you either agree or you don’t.
There is another group, with an interesting and testable claim. They argue that investing in socially responsible manner is a useful vector to improve portfolio peformance, and that it is easier to optimise for financial returns if one also consider social indicators. The theory goes, “since most investors do not consider the SRI characteristics of their investments, and since this is an important vector for good returns, the market is not entirely efficient and investors using an SRI approach will outperform the market”
As I mentioned, this is a testable hypothesis. EDHEC has produced a research report (Socially Responsible Investment Performance in France [pdf]) which shows that over the period in question SRI does not produce positive alpha on its own. They used the three-factor Fama-French model to determine expected returns, which is a commonly used approach and has fair academic credibility. This research basically concludes that we cannot reject the null hypothesis that SRI does not produce an advantage. We can’t accept the view that SRI does no good, but this study shows no support that it does any good.
It may still be responsible for a pension fund to investment members’ money in an SRI manner. However, this seems to be more for the social good perspective and less for the financial return perspective.