The Wages of Social Responsibility

Typical socially responsible investors tilt their portfolios toward stocks of companies with high scores on social responsibility characteristics and shun stocks of companies associated with tobacco, alcohol, gambling, firearms, and military or nuclear operations. Analyzing 1992–2007 returns of stocks rated on social responsibility, this study found that this tilt gave such investors an advantage over conventional investors. The study also found that shunning resulted in a disadvantage for such investors relative to conventional investors. The advantage from tilting toward stocks of companies with high social responsibility scores is largely offset by the disadvantage from the exclusion of stocks of shunned companies. Socially responsible investors can thus do both well and good by adopting the best-in-class method in constructing their portfolios: tilting toward stocks of companies with high scores on social responsibility characteristics but refraining from shunning stocks of any company. Typical socially responsible portfolios are tilted toward stocks of companies with high scores on such social responsibility characteristics as community, employee relations, and the environment. We analyzed the 1992–2007 returns of stocks rated on social responsibility characteristics and found that this tilt gave socially responsible portfolios an advantage over conventional portfolios. This finding is consistent with the “doing good while doing well” hypothesis, whereby the expected returns of stocks of socially responsible companies are higher than those of conventional companies. Typical socially responsible portfolios, however, also shun stocks of companies associated with tobacco, alcohol, gambling, firearms, and military or nuclear operations. We found that such shunning results in a disadvantage for socially responsible portfolios relative to conventional portfolios. This finding is consistent with the “doing good but not well” hypothesis, whereby the expected returns of socially responsible stocks are lower than those of conventional stocks. For socially responsible portfolios, the advantage from the tilt toward stocks of companies with high social responsibility scores is largely offset by the disadvantage from excluding stocks of shunned companies. The net effect is consistent with the “no effect” hypothesis, whereby the expected returns of socially responsible stocks are approximately equal to the expected returns of conventional stocks. This finding is consistent with a world in which the social responsibility feature of stocks has no effect on returns. But it is also consistent with the world we found, in which the advantages of some social responsibility criteria are offset by the disadvantages of other social criteria. Socially responsible investors can do both well and good by adopting the best-in-class method for the construction of their portfolios. That method calls for tilts toward stocks of companies with high social responsibility scores on such characteristics as community, employee relations, and the environment, but it also calls for refraining from shunning the stocks of any company. Editor’s Note: This article is based on the authors’ working paper that won the 2008 Moskowitz Prize for Socially Responsible Investing.