The Price of Ethical Investing: Evaluating the performance of socially responsible indices

Abstract

We use a Fama-French based approach to investigate the risk-adjusted performance of five regionally diverse sets of SRI indices and their conventional benchmarks from 1997 to 2014. In accordance with most previous research, we find that SRI indices perform on par with their benchmarks in the long run. However, we postulate that SRI screening leads to increased idiosyncratic risk and that this will translate into inferior risk-adjusted returns in periods of falling markets. Expanding on the Fama-French approach with dummy variables for the Dotcom Fall in the early 2000s and the Financial Crisis of 2007 to 2009, as well as adjusting for variations in the market, size and value premiums in these periods, we find that SRI underperforms in periods of falling markets. As a result, we argue that socially responsible investors with a long investment horizon should not expect inferior financial returns, but investors with a shorter investment horizon should be wary of SRI.