Aurora Borealis
1 May 2013 CFA Institute Journal Review

The Return-to-Risk Performance of Socially Responsible Investing According to Catholic Values (Digest Summary)

  1. Martin A. Wildy, CFA

The authors explore the relationship between corporate social responsibility policy and corporate financial performance by studying the performance of stocks that are screened using guidelines published by the United States Conference of Catholic Bishops. They determine that investing according to the guidelines is detrimental to investment performance.

What’s Inside?

The authors add to the existing body of research on the relationship between corporate social responsibility policy (CSP) and corporate financial performance (CFP). They seek to understand the link between Catholic social values and CFP by comparing the risk-adjusted returns of stocks with high scores according to the guidelines of the United States Conference of Catholic Bishops (USCCB) with those of stocks with lower scores. The authors find that, for the periods examined, investing according to the USCCB’s social screening guidelines is detrimental to risk-adjusted returns. Policy recommendations are then offered for Catholic institutions using these guidelines.

How Is This Research Useful to Practitioners?

Much of the existing research on the impact of social screens on investment performance identifies social screening factors as having a neutral to positive influence on investment returns. The authors, noting that much of this research was published in the 1990s, seek to add to the literature on the subject.

They analyze returns of social indices and individual stocks that are based on the USCCB’s screening guidelines and perform regression analyses on returns of the KLD Catholic Values 400 Index, KLD Domini 400 Social Index, S&P 500 Index, and CRSP Value-Weighted Index. The results demonstrate that the KLD social indices underperformed during May 1998–December 2007.

Next, the authors examine the returns of individual stocks and reach a similar conclusion. They find that the best-performing companies on a risk-adjusted basis are more often the companies with the lowest socially responsible investing (SRI) scores. Specifically, the 94 best-performing securities include 34 from the top SRI quintile and 60 from the bottom SRI quintile. SRI scores are higher for stocks with lower risk-adjusted returns and lower for stocks with higher risk-adjusted returns. The authors also identify a relationship between economic sector, SRI score, and investment performance. The top three sectors by SRI ranking (financials, consumer staples, and discretionary) have below-average performance rankings. Conversely, the two sectors with the lowest SRI rankings (industrials and energy) have above-average performance rankings.

The authors conclude that Catholic social screens were detrimental to returns during the study period. They recommend that investors relax negative SRI screening constraints and focus on shareholder advocacy. They also advocate in-depth SRI sector analysis, sector rotation, and security analysis to improve returns.

This article will be of interest to practitioners and investors in the field of SRI, particularly those directly involved with institutions that invest according to Catholic social guidelines.

How Did the Authors Conduct This Research?

The authors use the USCCB social investing guidelines to construct SRI scores using the IW Financial database. These guidelines include protecting human life, promoting human dignity, reducing arms production, pursuing economic justice, protecting the environment, and encouraging corporate responsibility. It is not clear how the authors convert these general guidelines into the specific scoring profiles.

One limitation of this study is the inability of the IW Financial database to allow for historical screening. As a result, all of the securities are ranked by the IW Financial score on 27 June 2007 and divided into five quintiles, which restricts the authors’ ability to determine whether the SRI quintiles would have changed during the sample period or to test whether CSP leads CFP. In addition, IW Financial does not have any screens related to predatory lending practices, which may have affected the SRI rankings of financial firms.

For data on individual security performance, the authors use the CRSP dataset. Monthly total return data are for 1 January 2003–31 December 2007, and daily return data are for 28 June 2007–31 December 2007. Index return data are obtained from CRSP and SunGard FactMaster. The authors run data tests using a portfolio management software program. A variant of the Sharpe ratio known as the reward-to-semivariability ratio is used to rank securities by risk-adjusted performance for comparison purposes.

The impact of the macroeconomic environment on sector returns during the study period is also discussed. For example, during the six-month period of daily returns in late 2007, a steady increase in energy prices benefited the energy sector, which had a low SRI ranking. The authors do not analyze returns by social screening factor.

Abstractor’s Viewpoint

The authors provide a good overview of existing research that links CSP with CFP, and their own research adds to the literature. They provide detailed insight into the performance of securities adhering to Catholic social investing guidelines. But some questions remain unanswered. The limitations of the social screening database and the impact of sector performance during the sample period make the conclusions less concrete. An examination of the results on a sector-by-sector basis, to control for the macroeconomic environment, would have been beneficial. It would also be interesting to see this work expanded to provide attribution by social screening factor.

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