SRI Notes

Who Are These Guys?

A bit of a shock from Financial Times this morning:  "Large ethical companies consistently outperform the market, according to a survey of corporate social responsibility by Goldman Sachs, the investment bank."

Well, not really.  The report actually asserts that SRI indexes have historically underperformed, and offers this comment:  "one explanation for the historical relative underperformance of various SRI and/or ethical investment indices is the lack of integration with financial analysis". 

I'm sympathetic with the thought - social factors do need to be better-integrated with mainstream securities analysis.  But there's actually not much evidence to support what they're saying about performance.  Social investments haven't historically underperformed (for a long discussion of this see my 2005 Journal of Investing paper), and despite a rough three years the Domini Index is still ahead of the S&P 500 from inception.  If you're keeping score, it's currently Domini +12.1% (annualized return) vs. S&P 500 +11.5% from inception (5/90).  Major variations in performance appear to be explained by the Fama & French factors.  When you adjust for those factors, the big problem is explaining why the Domini index seems to have positive alpha. 

[Non quantitative readers can skip this note.  But if you're quantitatively inclined you can do your own analysis of the Domini numbers using the Fama & French factors from Ken French's website.  William Bernstein gives excellent step-by-step instructions here.  If you're in business school, ask your finance professor why the intercept is positive.  You'll get some interesting answers.]

The report is saying that certain companies Goldman Sachs likes have outperformed, and it introduces the GS SUSTAIN methodology to identify these companies going forward.  The report says that "our methodology is not designed to be comprehensive, nor is it designed to be prescriptive in judging what is good or bad practice."  (If you don't have access to Goldman research, this Associated Press article is a good backgrounder on the report.)

Peter Kinder has usefully divided social investors into three groups:

• Values-based investors - investors whose values drive portfolio construction with relatively little attention to the financial impact of those decisions
• Value-seeking investors - investors seeking to improve investment performance through the use of social or environmental variables
• Value-enhancing investors - investors that use shareholder engagement to increase shareholder value, but do not otherwise view themselves as 'socially responsible'

The Goldman report falls under the second heading.  They are not trying to make distinctions about what is right or wrong, or to serve a particular type of social or environmental investor.  The SUSTAIN project instead represents a serious effort to integrate stakeholder analysis with securities analysis, with a view toward improving investment returns.  That's a smart thing to do, and mainstream portfolio managers should take a hard look at it.

Two Perspectives on Our Significance

If you're over thirty, you're accustomed to a world in which the U.S. was a dominant, or even the dominant economic player.  For all the talk about the emergence of economies like India and China, on official statistics, they still pale in comparison to the U.S., as this intriguing map shows.

But the standard GDP comparison is flawed for many purposes.  By most intuitive measures of wealth, China and India should rank higher than they do on that map.  It turns out that one reason for the discrepancy is exchange rates.  If you compare apples to apples using purchasing power parity (a nice apartment in Beijing vs. one in San Francisco, for example), you get a very different picture, as this list from the CIA World Factbook shows.

I suppose there are important reasons why a dollar should buy three times more stuff in, say, Malaysia, than it does here.  Many Asian governments don't mind a weak currency vs. the dollar because it's good for exports.  America, meanwhile, has a lot of rich older consumers who like buying good stuff cheap.  So, in an odd sense, even though cities like Singapore, Hong Kong, and Kuala Lumpur are as 'developed" as, say, Albany, we set our terms of trade as if they were not (if you haven't seen it lately, here is a fairly recent picture of Kuala Lumpur). 

Economists have taken to calling this state of affairs "Bretton Woods II" - a reference to the de facto fixed exchange rate system of the post-WW II era.

The world view you choose to believe depends a lot on how long you think the Bretton Woods II arrangement will last.  Some view it as benign, even optimal (as this paper suggests).  Others have a darker view.  I  believe it is unravelling gradually - most Asian countries have already abandoned their dollar pegs (China and Hong Kong are big exceptions).  And a money manager we know recently reported that a nice house in downtown Hanoi is running about $1 mm.

We Americans are used to being listened to.  Other countries benchmark against us and look to us for value-added products and know-how they have not yet developed.  As things progress, it's unlikely we'll remain the largest economy in the world.  We may retain our technological edge, but the gap will likely narrow.  And in some instances, the rest of the world will get ahead of us, and we will find that we have something to learn.

Independence Day is a good time to think hard about what we understand well and what we don't - what we have to teach the world, and what the world has to teach us.  But I wouldn't take that map too seriously.  As the proverb goes, "do not make yourself so big, you are not so small."

Costing the Atmosphere

I'm a bit behind in my reading, but enojyed this piece from The Economist's special report on business and climate change, particularly the graph (sourced from the Swedish utility Vattenfall). 

The Economist correspondent drily observes that "people buy houses not because they have good insulation but because they have pretty views."  One might say the same thing about why (most) people buy stocks and mutual funds - which might, in turn, explain their results (the mutual fund version is here).