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.