Jeffrey MacDonald at The Christian Science Monitor has made corporate social responsibility his beat. His latest piece, on how companies are acting more quickly to address social and environmental concerns before they get out of hand, is excellent.
The Monitor's website has an 'Ethical Investing' section, with an archive of his past stories and a series of video interviews (by Laurent Belsie) with social investment practitioners.
Back in the early 70s there was a significant surge in interest in socially responsible investing. There was lively debate with articulate advocates like Milt Moskowitz (book plug here) writing in the New York Times, and smart people like Milton Friedman and Burton Malkiel (see his speech in this anthology) raising concerns about the emerging practice.
And that was really the high-water mark for a long time. The general interest in social investing sharply tapered off as the energy crisis hit and the Nifty 50 era came to a crushing end with the 1973-74 bear market.
The present era bears a lot of similarity with those days. Oil prices are through the roof, and with the $100 forecast now looking kind of plausible, the hot new forecast is for $200 oil.
And yet interest in SRI has never been stronger. You see SRI in places it has never appeared before, like The Motley Fool and Value Line (thanks to Lorne Abramson for the tip on that one).
I suspect some of this has to do with the sophistication of the tools available today - social investors can manage portfolio risk in ways they couldn't in the 1970s. Also, there are more funds in different styles, including some good value and and contrarian choices, so performance hasn't been universally poor during the energy bull market of the past three years, despite the weak recent returns of the social indexes.
I wrote last year about the energy problem - the underperformance of some social indexes as energy stocks took over the market in recent years. It is not just an energy problem, it's a utility problem, too. Here are the returns to the S&P 500 by sector for the three years ended 8/6/06 (source: Bloomberg):
| Energy | 131% |
| Utilities | 66% |
| Materials | 43% |
| Industrials | 39% |
| Financials | 33% |
| Telecom Serv | 32% |
| Cons Staples | 25% |
| Cons Disret | 20% |
| Health Care | 14% |
| Info Tech | 14% |
Many social investors avoid both energy companies and utilities - energy companies because of their environmental problems, and utilities because most are involved in nuclear power. Whether these restrictions make sense can be debated. A financial academic once asked me why we excluded stocks that will outperform with higher energy prices when they are the best thing that could happen to the alternative energy sector (they create a subsidy to development of cleaner energy). And some influential people are arguing that, given our climate issues, nuclear could be part of the solution (Socialfunds covered this very well last summer).
Anyway, it's hard to outperform when you're underweighted the two best-performing sectors in the market. The Domini Social Index is still ahead of the S&P 500 from inception and over the past ten years, but its three year record has been well behind the broader market as of 7/31/06 (annualized +8.5% vs. +10.8% - full performance details here). The Calvert Social Index is in the same boat, up 8.0% over the same period (performance details here).
There are a couple of points I'd like to make about this:
And finally, I get a chance to mention the Canadia social research firm Jantzi Research on this blog. Founder Michael Jantzi has been involved in social research since 1990, and knows what he's doing. They have just published a report reviewing the sustainability records of 23 large energy companies. BP comes out at the top of the heap, which is consistent with other research I've seen.
There have been many studies of the impact of CalPERS' corporate governance program on stock prices. Studies from CalPERS staff and consultants have argued that the program added significant value (see discussion here). But other studies have found a less powerful effect (example here), and still others question whether there is a 'CalPERS Effect' at all (example here).
Now Brad Barber at Cal Davis has done what appears to be a careful and comprehensive study of stocks named on the CalPERS Focus List, 1992-2004. He finds a small-looking 25 basis point positive benefit. Small, until you realize those 25 basis points translates into wealth creation of $3.1 bn.
Steven Levitt, author of Freakonomics, spoke earlier this spring at Boston College's International Corporate Citizenship conference. A brief account of his remarks is here.
I point this out because Levitt is exactly the kind of person we need to get more involved in the global exchange of views on corporate social responsibility (CSR) and socially responsible investing (SRI).
I have come to believe that CSR and SRI have too many normative critics, and not enough positive ones. That is, there is a good supply of people to criticize social investors for holding the values they hold, or for the way they act on those values (examples here and here). But there are not enough who bring quantitative sophistication and fresh perspectives to the study of these problems.
Good positive critics can be scary - they question your assumptions about how things work, they make you look at uncomfortable facts, they present analysis that doesn't fit your world view. But that kind of engagement can also be transformative - it may be the only way CSR and SRI can move meaningfully forward from their current practices.
Levitt has what it takes to be a valuable positive critic - he is curious about how things work, he is not afraid to tackle difficult or controversial subject matter, and he is brilliant at question-framing.
Hats off to BC for inviting him.
I've expressed skepticism in the past that the sell side could add much to the social investment world, but there is a lot going on now, some of it very interesting.
Daniel Fermon, Senior Europe Strategist at Société Générale, is doing work that incorporates traditional financial research, social/governance research (from Société Générale's SRI researchers, Sarbjit Nahal and Valéry Lucas-Leclin), and his own innovative views on the role of the CEO in investment returns. There is a brief but interesting interview with him here.
In coming years I believe markets will gradually grow more efficient with respect to traditional investment variables such as valuation and momentum, making it tougher for traditional investment strategies to add value. As that happens, researchers will have to dig deeper into predictors of sustainable value creation, such as management quality and governance. Fermon's work shows how this type of analysis can be done.
I had a chance over the past two weeks to spend some time reading Deirdre McCloskey's How to Be Human* : *Though an Economist, a collection of her essays from the 1990s, many of which were first published in the Eastern Economics Review. I recommend the book. It is readable and informative, but, for reasons that will become apparent, also poses significant challenges to the reader.
The first thing to know about McCloskey is that she writes well, well enough to have authored an influential writing text for economists. If you believe clear writing reflects clear thinking, McCloskey is one of the clearest thinkers alive. But, she says, this is not typical in her profession:
The main cause of bad writing in economics is that economists don't read good writing. If economists would read Jane Austen or George Orwell, or even Adam Smith or JM Keynes or Thomas Schelling, in bulk, daily, habitually, they would improve. (p 131)
The second point to make about Deirdre is that, until 1995, she was Donald McCloskey, a prominent economist at the University of Iowa (following stints at Harvard and the University of Chicago). The Economist, in its excellent 2004 article on her recent work, never mentions this - an impressive indication of how different that magazine is from its more sensational competitors. But McCloskey herself thinks it is important, and chapter one of How to Be Human* describes some elements of what must have been an extraordinarily stressful period in her life.
No, I am not gay. I am cross-gendered, and at age 53, having been a good soldier for over four decades, I am doing something about it... I'm going to become a tall and ugly but indubitably female economist. I go full time in November 1995... Why would anyone do such a thing? The "why" question has the usual answer we give in economics: stop asking it, since you might as well ask people why they like chococate ice cream. (p 3)
McCloskey is, unsurprisingly, very alert to gender issues in economics, as this commentary on Lester Thurow's The Zero Sum Society suggests:
Thurow's football trope is not innocent. Instead of trade as a sport in which everyone benefits, like aerobic dancing, the metaphor invites us to think of it as yardage extracted from one's trading partners. The path is short - a path taken by England and Germany 1890-1914 - from sporting metaphor to the guns of August. Stories matter. (p 122)
I understand The Economist's reluctance to even mention McCloskey's gender status - it is the sort of thing that will lead many people to dismiss her arguments out of hand. That is a major loss, because McCloskey is one of the most important critics of economics as it is practiced today.
Simply put, McCloskey thinks most modern economics has been done wrong and will have to be re-done. She believes that economists' obsession with statistical significance (as opposed to real economic significance, or "oomph"), abstract analysis ("blackboard economics"), and social engineering have severely undermined the field's practical significance.
The late Richard Feynman, a Nobel laureate in physics, introduced a few simple theorems in matrix algebra into his first year class at California Institute of Technology with considerable embarrassment: "What is mathematics doing in a physics lecture?... Mathematicians are mainly interested in how various mathematical facts are demonstrated... They are not so interested in the result of what they prove." Feynman's rhetorical question startles an economist. In advanced economics it would be: "What besides mathematics should be in an economics lecture? (p 216)
Her 1997 book The Vices of Economists; The Virtues of the Bourgeoisie gives a careful and detailed exposition of this argument, but How to Be Human* includes an excellent summary, entitled "Ask What the Boys in the Sandbox Will Have". Unlike others who have been in her intellectual position, she takes little delight in what she believes are the misfortunes of economists.
The sadness is that economists, mainly men, are confident that their mechanical methods are correct and produce correct results. The men stride about offering advice to governments and criticisms of each others' work as though they were doing real science... They are of goodwill and have good minds. They do not deserve to end up with a science lacking scientific findings. No one with an ounce of human pity would be happy that such a good group of men are so wrong.
The scene is like an aunt watching her three-year-old nephew and his friends playing in a sandbox... Yes, David, you are building a great fort in the sand. My, how wonderful. Yes, Gerard my dearest, yes. (pp 234-235)
Social investors, who protest that the assumptions of economic models are simplistic and incomplete, may take McCloskey to be an ally. In this fight she certainly is. But nothing I have read of hers suggests a left/liberal world view. She is a self-described libertarian, and deeply suspicious of government programs that meddle in the economy. But when she says "we have learned that one cannot solve great social questions standing at blackboard," many of us will say Amen.
One man everyone involved in SRI should pay attention to is David Swensen of Yale University. His performance has been exceptional - over the past 2o years the Yale Endowment's returns have been the best of any educational institution. His books, Pioneering Portfolio Management and Unconventional Success, are excellent.
This has been accomplished despite at least some social constraints. Yale has an Advisory Committee on Investor Responsibility, and during the South Africa boycott the endowment divested its holdings in companies doing business in South Africa.
Marc Gunther, a journalist at Fortune magazine and the author of the excellent Faith and Fortune, is also a Yale alum and has written this profile of Swensen for the Yale alumnae magazine. It includes commentary both on Yale's social investment policies, as well as those of other schools (notably Williams, which now has a 'Social Choice Fund' available).
Swensen is not the only investor to achieve superb results despite social constraints. Sir John Templeton, widely regarded as one of the finest investors who ever lived, avoided alcohol, tobacco, and gambling stocks for religious reasons throughout his career.
Moskowitz Prize judge Pietra Rivoli's new book, The Travels of a T-Shirt in the Global Economy, was one of six shortlisted for this year's FT/Goldman Sachs Business Book of the Year Award. Today's Financial Times includes an excerpt from the book and some quotes from Pietra (link here, but subscribers only...).
Some other links:
If you have a financial background, I'd also strongly recommend the paper Pietra did with Georgetown colleague James Angel in 1997. There is a brief but good plain-English article on the study on page 5 of this issue of Georgetown Business magazine.
If you a make a list of financial theorists who have 1) taken a long-term interest in social investing, 2) published numerous studies of SRI in refereed journals, and 3) engaged social investors constructively about their work, you basically get one name: Meir Statman.
Since he won the Honorable Mention in this year's Moskowitz Prize competition and headlined the Journal of Investing special SRI issue with a different article, I thought I'd provide a little additional background on him and his work. Here are his studies that bear directly on SRI:
I first ran across Meir's work when I was studying the diversification impact of social screens in the late 1980s and early 90s. In those days conventional wisdom held that 30 stocks should be enough to adequately diversify a portfolio. But in 1987 Meir's "How Many Stocks Make a Diversified Portfolio" showed that the number was much higher, possibly in the hundreds.
I figured that finding was good for a social index - it strongly suggested that broad indexes could offer a risk advantage over more concentrated portfolios. But it was also a cautionary note for social investors who were counting on the "Rule of 30" to protect them from diversification costs introduced by the social screens. It convinced me that social investors needed to be really careful about diversification, a conviction I still hold today. (A brief abstract of this study appears at sristudies.org.)
Meir's best-recognized work is not in the SRI field, however. He is regarded as one of the pioneers of Behavioral Finance, and his most-cited work is a Journal of Finance article, about the tendency of investors to sell winners too soon and hold losers too long. The full citation for Shefrin and Statman (1985) can be found here.
Social investors should take careful note of Meir's work, because many of his papers go well beyond the bounds of traditional finance and raise questions about the interplay of markets and human psychology. I am thinking particularly of his paper on fair trading, which has ethical and moral significance well beyond its contribution to the financial literature.
I asked Meir which of his writings he thought newcomers should look at, and he suggested "Normal Investors, Then and Now", which recently appeared in Financial Analysts Journal. There is a good interview with him here.
Meir has made a serious study of social investors. Social investors would be wise to return the favor.
