Measuring the Cost of Socially Responsible Investing

Socially responsible investing (SRI) has been around, in concept and practice, at least since the movement to divest institutional endowments of the holdings of the stocks of companies doing business in apartheid South Africa. It continues to this day, with new principles determining what is socially responsible. Some investors would avoid the stocks of corporations that produce fossil fuels, others would divest of tobacco companies, still others of companies doing business in Israel, and so forth. Some would combine multiple social principles into one set of restrictions. Although not normally considered SRI, there is a much longer tradition of shunning the securities of companies to which investors object on ethical or religious grounds, as when some individuals or organizations refuse to buy the stocks of companies that produce alcoholic beverages or, in the case of the Church of Christ, Scientist, pharmaceuticals. Investors have demanded SRI, and investment management companies have been founded for the purpose of providing investment advice that conforms to it.

Quite apart from its motivations, the consequences of this kind of investing have intrigued analysts. The actual results, as distinct from the desired results, cannot be taken for granted. There have been a number of papers reporting research into what happens to portfolios that are managed in a way deemed to be socially responsible.

Mark Kritzman, the well-known quantitative analyst and chief executive officer of Boston-based Windham Capital Management, published a paper on this subject, in collaboration with his colleague, Timothy Adler, several years ago.1 He spoke about his analysis at a recent meeting of analysts in Boston. He said that their paper was little noticed until recently, when SRI achieved renewed prominence in the form of popular demands that institutional portfolios divest themselves of investments in fossil fuel companies.

Kritzman’s point, and the conclusion of his analysis, is that socially responsible investing, properly understood, incurs a cost to the portfolio. The context of his analysis is active portfolio management, with stock selection. His conclusion does not apply to passively managed portfolios, that is, portfolios designed to mimic socially responsible investment benchmarks.

1. Timothy Adler and Mark Kritzman, “The Cost of Socially Responsible Investing,” Journal of Portfolio Management, Fall 2008, vol. 35, no. 1, pp. 52.56.