With the tilting toward growth over value, socially responsible funds – funds that screen potential investments according to social or ethical criteria – may find that their portfolios will suffer over time. This contention is based on research that found the average value stock outperformed the average growth stock by 3.5% points a year, annualized, over the last 77 years, according to a study by the Wharton School of the University of Pennsylvania reported by the New York Times.
However, the Wharton study appears to fly in the face of earlier reports that concluded on average socially responsible funds outperformed other stock mutual funds in the 1990’s. This assertion the Wharton report attributes to the bursting of the technology bubble and many of the earlier studies being conducted while the good times were still rolling because a typical socially responsible fund has an outsized allocation to tech stocks, so its strong performance in the 1990’s might have reflected no more than that sector’s strength.
Further, the heavy allocation to technology may also help to explain the socially responsible stock funds’ recent relative strength. Socially responsible funds produced an average gain of 15.5% in the second quarter, slightly better than the 15.4% total return for the S&P 500, according to data from Lipper Inc.
The large representation of technology stocks among many socially responsible funds is due to how well these companies score on the funds’ screens. To break down the allocations and get to the heart of the socially responsible returns, the three researchers at the Wharton School, Professors Christopher Geczy and Robert Stambaugh and graduate student David Levin, analyzed socially responsible funds in light of market factors that historically have been most correlated with fund performance, like the average market capitalization of a fund’s stock holdings or where its stocks fall on the value-growth spectrum. Within the universe of socially responsible funds, they found that there is a smaller range of meaningful choices among these factors. Over time, they say, that reduces returns for investors who build a portfolio of such funds.
Additionally, the Wharton researchers tested other assumptions about market performance. In each case, they found that the smaller range of meaningful choices among socially responsible funds reduced investors’ likely returns, often by several points a year.
The complete study can be found at http://finance.wharton.upenn.edu/~geczy/Papers/GSL_sri_paper_5_26_2003.pdf.