Revisiting “The Cost of Socially Responsible Investing”

The following is in response to the ongoing exchange of letters regarding socially responsible investing:

Endowments have been warned that socially responsible investing (SRI) incurs a financial cost, based on research by two prominent academicians. But that research – which has been presented and debated in this publication – is based on a tenuous model that is highly sensitive to its assumptions. Change those assumptions reasonably, as I did in my research, and the cost of SRI becomes trivial.

Recently, Swarthmore College’s Vice President for Finance and Treasurer Suzanne P. Welsh, and Christopher M. Niemczewski, Chair, Investment Committee, Board of Managers, determined that the financial cost of divesting the college’s endowment from fossil-fuel securities would be over $15 million over a 10-year period. They cited as justification a paper published in 2008 by Timothy Adler and Mark Kritzman (A-K) on the financial cost of socially responsible investing. In addition, Kritzman has promoted the cost estimates of this paper in other discussions about colleges and universities divesting from fossil-fuel securities, describing foregone returns in the hundreds of millions of dollars.1 These events sparked my own interest in this research and, as time passed, my surprise that no response discounting these costs appeared. As an academic with expertise in economics and econometrics, I waited for a financial expert to provide a critical review.

The A-K paper finally received discussion on Advisor Perspectives, starting with a report by Adam Jared Apt about a talk on the subject Kritzman gave at a recent meeting of analysts in Boston. Adam Kanzer commented on Apt’s description of Kritzman’s argument and on the original paper. In subsequent letters to the editor, Kritzman and Apt both responded to Kanzer, who replied back. Finally, Apt responded to Kanzer’s rejoinder. Much of this discussion centered on characterizations of active management and socially responsible investing.

In view of this discussion, I acknowledge at the outset that a constrained maximum is less than or equal to a corresponding unconstrained maximum so that if active management were optimal (in some ex ante sense) then active management constrained by socially responsible criteria would be suboptimal (in the same ex ante sense). At the same time, I note that whether socially responsible investment will actually incur a financial cost is unclear for many well-understood reasons: returns are uncertain, managers are imperfect, and optimal does not mean maximum expected return to everyone.2 So the argument by Adler and Kritzman that “socially responsible investment is costly” is facile, though I would predict – with a lot of uncertainty – SRI incurs some small cost.

1. See "Panel weighs costs, benefits of divestment (story & video)", January 23, 2013 and Mark Kritzman, “What Fossil-Fuel Divestment Would Cost,”The Chronicle of Higher Education, March 18, 2013.

2. For example, see the comments at the end of Apt’s initial report and his first letter to the editor.

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