Download A Framework for Social Investment Practice (Rough

Fiduciary Aspects of Social Investing
Lloyd Kurtz
Sr. Portfolio Manager
Nelson Capital Management
Santa Clara County Estate Planning Council
April 23, 2007
1
Topics




Background on Social Investing
Diversification
Performance
Evidence of Social Outperformance?
2
Background on Social Investing
3
Key Moments in the History of SRI
Socially responsible investing has a long history
19th Century: Religious investors
avoid investing in alcohol, tobacco,
1980s: Religious investors join
gambling, weapons manufacturing,
forces with the Nuclear Freeze
and other objectionable activities
Movement and church groups in
South Africa
1971: Pax World Fund
founded, first socially
1989: Launch of Domini Social
screened mutual fund
Index, first broad-based social index
1971
1980
1989 – DSI 400
4
Money and Faith
“In the New Testament, Jesus had more to say about
money matters than any other single subject, be it
worship, sexual behavior, violence and peace, or even
eternal life...for those who would follow Jesus, economic
questions are really spiritual questions.”
- Burkholder (2002)
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Social Investment Strategies

‘Negative Screening’
 Excludes companies violating social screens

Positive Screening’
 Seeks to proactively include exemplary companies

‘Shareholder Activism’
 Promotes change through negotiation and shareholder
resolutions

Community Investing
 Direct investment through micro-lending, social venture, and
other mechanisms.
6
Socially Responsible Investing in the U.S.
Socially Responsible Investing in the U.S. reached $2.3 trillion in 2005
Screening +
Shareholder Advocacy
5%
$117 billion
Community
Investing
1%
$20 billion
Shareholder
Advocacy Only
26%
$586 billion
Screening Only
68%
$1,568 billion
Source: Social Investment Forum, SRI Trends Report 2005
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Types of Social Investors
Institutional investors in SRI include:
Religious Organizations

Catholic

Methodist

Christian Science

Islamic
Family Offices
Non-profits (“Mission-Based Investing”)
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Prevalence of Different Social Screens
Mutual Fund Assets by Screen Types
Tobacco
Alcohol
Gambling
Defense/Weapons
Community Relations
Environment
Labor Relations
Products/Services
Equal Employment
Faith-Based
Pornography
Human Rights
Animal Testing
Other
0
25
50
75
100
125
150
175
$ Billions
Source: Social Investment Forum, SRI Trends Report 2005
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Diversification
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ERISA

“A fiduciary must diversify the plan
investments so as to minimize the risk of
large losses, unless under the circumstances
it is clearly prudent not to do so.”
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Uniform Prudent Investor Act of
1994

“A trustee shall diversify the investments of
the trust unless the trustee reasonably
determines that, because of special
circumstances, the purposes of the trust
are better served without diversifying.”
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CFA Institute
“Diversify. Members and candidates should
diversify investments to reduce the risk of
loss, unless diversification is not consistent
with plan guidelines or is contrary to the
account objectives.”
- CFA Institute Standards of Practice Handbook, 2007
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Two Areas of Apparent Latitude


No quantitative guidance as to how much
diversification is enough.
Some provision in the language for
exceptions based on the individual situation.
14
More Stocks Improve Diversification
60
Average Portfolio Std Deviation %
50
40
FirmSpecific
Risk
30
20
10
Based on data in M. Statman, "How Many Stocks
Make a Diversified Portfolio?" Journal of Finance
and Quantitative Analysis 22 , September 1987.
Market
Risk
0
1
2
4
6
8
10
20
30
40
50
100
200
300
400
500
1000
Number of Stocks in Portfolio
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Comparison of Three Funds
# of Holdings
iShares Goldman Sachs
Technology Index Fund
(IGM)
iShares S&P Global 100
Index Fund
(IOO)
S&P 500
233
104
500
Std. Dev., Last
Five Years
Largest
3 Holdings
(and %)
24.8%
MSFT – 8.3%
CSCO – 6.5%
IBM – 6.0%
13.0%
XOM - 5.0%
GE - 4.3%
C - 3.1%
12.4%
XOM - 3.4%
GE - 2.8%
C - 2.0%
Sources: iShares website, March 2006, Zephyr
performance system.
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Theory Says: Own Everything
In modern portfolio theory,
the market portfolio (point P)
offers the best combination
of risk and return. This can
be accessed via a low-cost
index fund.
The argument theorists
make against social
investing is the same they
make against active portfolio
management.
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Performance
18
Sin Has its Rewards...
400%
350%
Total Return, 3/97 - 3/07
300%
250%
200%
150%
100%
50%
0%
S&P 500
S&P Tobacco
S&P Brew ers
S&P Casinos
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But Social Investors Have Done OK!
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Overall Performance
Annualized Returns
Past Ten Years
Domini Social Index
+8.3%
S&P 500
+8.2%
Domini Return Differences Likely Due To:

Slightly Higher beta

Modest growth bias

Sector weights

Overweighted in Technology, Consumer

Underweighted in Energy, Utilities
Source: KLD Website, as of March 31, 2007.
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Complex Attribution Studies

Equities
 Kempf and Osthoff (2006)



Geczy (2003)



1963-2006
No SRI Effect
Bauer, Koedijk, and Otten (2002)



1992-2004
Small Positive SRI effect
1963-2001
No SRI Effect
These studies all
use the Carhart
model, which
accounts for style,
market
capitalization, and
momentum effects.
Fixed Income
 Derwall and Koedijk (2006)

No SRI Effect
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DS 400 Index, 5/90 – 12/06
Fama/French Regression of Monthly returns
SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
97%
95%
95%
1.00
200
That is not supposed to be
a positive number.
Not statistically significant, however.
ANOVA
df
Regression
Residual
Total
Intercept
Mkt-RF
SMB
HML
3
196
199
SS
3,462.79
195.49
3,658.28
Coefficients Standard Error
0.11
0.074
1.01
0.020
(0.21)
0.021
(0.07)
0.027
MS
1,154.26
1.00
F
Significance F
1,157.27
0.000%
t Stat
P-value
1.45
14.9%
50.48
0.0%
(9.56)
0.0%
(2.59)
1.0%
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
(0.04)
0.25
(0.04)
0.25
0.97
1.05
0.97
1.05
(0.25)
(0.16)
(0.25)
(0.16)
(0.12)
(0.02)
(0.12)
(0.02)
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The Energy Problem
Annualized Returns
Past Three Years
Domini Social Index
+ 8.0%
S&P 500
+10.1%
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Evidence of Social Outperformance?
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Two Interesting Areas


Environment
Governance
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Studies Showing an Environmental Effect

Guenster,Derwall, Bauer, and Koedijk (2005)



Derwall, Bauer, and Koedijk (2005)



1996-2002 time period
Shows stocks ranked highly by Innovest had higher valuation ratios and
capital efficiency ratios.
1995-2003 time period.
Backtest shows highly-rated stocks outperformed lowly-rated ones.
Dowell, Hart, and Yeung (2000)

Favorable impact on price/book ratios

Cohen, Fenn, and Konar (1997)

Russo and Fouts (1997)
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Is There a CalPERS Effect?
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Constructing the CalPERS Focus List

Quantitative Screen




Qualitative Review







Stock Performance
Capital Efficiency
Corporate Governance
Overall financial performance
Valuation
Strategic plans
Management and board member relations
Compensation Practices
Other miscellaneous shareowner issues (including takeover defense)
Engagement Process – Since Exit is Impossible, Try Voice

“CalPERS considers the engagement process to be a crucial component of
the overall Focus List Process. CalPERS makes a persistent effort to meet
with the management and directors to discuss performance and governance
issues. CalPERS will focus on reforming the company's governance
practices with an emphasis on accountability, transparency, independence,
and discipline.”
Source: CalPERS
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Short-Term Impact


Barber finds a “small, but reliably positive”
+0.25% effect on announcement date.
“My best estimate, based on conservative
short-term market reactions, indicates
CalPERS activism has resulted in total wealth
creation of $3.1 billion between 1992 and
2005.”
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Long-Term Impact
100
90
80
70
$ Billions
60
50
40
30
20
10
0
1 Day
2 Weeks
1 Month
6 Months
1 Year
2 Years
3 Years
4 Years
Source: Barber (2006)
5 Years
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Notes
Barber, Brad. “Monitoring the Monitor: Evaluating CalPERS’ Shareholder Activism.” Working Paper, University of California, Davis, March 2006.
Bauer, Rob, Kees Koedijk, and Roger Otten. "International Evidence on Ethical Mutual Fund Performance and Investment Style." Working Paper,
January 2002.
Burkholder, J.R. “Biblical Faith and Investment: Toward a Theology for ‘Making Money.’” Mennonite Mutual Aid, 2002.
Accessed at: http://www.mmapraxis.com/features/columns/feature_burkholder.html
Cohen, Mark, Scott A. Fenn, Shameek Konar. "Environmental and Financial Performance: Are They Related?" Working paper, May 1997.
Derwall, Jeroen, and Kees Koedijk. "Socially Responsible Fixed-Income Funds." Working Paper, Erasmus University, May 2006.
Derwall, Jeroen, Nadja Guenster, Rob Bauer, and Kees Koedijk. "The Eco-Efficiency Premium Puzzle." Financial Analysts Journal, March/April 2005.
Dowell, Glen, Stuart Hart, and Bernard Yeung. "Do Corporate Environmental Standards Create or Destroy Market Value?" Management Science,
August 2000.
Geczy, Christopher C., Robert F. Stambaugh, and David Levin. "Investing in Socially Responsible Mutual Funds." Wharton School, Working Paper,
May 2003.
Guenster, Nadja, Jeroen Derwall, Rob Bauer, and Kees Koedijk. "The Economic Value of Corporate Eco-Efficiency." Working Paper, Erasmus
University, July 25, 2005.
Kempf, Alexander and Peer Osthoff. "The Effect of Socially Responsible Investing on Financial Performance." Working Paper, University of Cologne,
Germany. June, 2006.
Orlitzky, Marc, Frank L. Schmidt, and Sara L. Rynes. "Corporate social and financial performance: A meta-analysis." Organization Studies, 24, 2003.
Russo, Michael V., and Paul A. Fouts. "A Resource-Based Perspective on Corporate Environmental Performance and Profitability." Academy of
Management Journal, June 1997.
Wesley, John. “The Uses of Money.” Edited by Jennette Descalzo, student at Northwest Nazarene College (Nampa, ID), with corrections by George
Lyons for the Wesley Center for Applied Theology. General Board of Global Ministries, The United Methodist Church, 2000.
Accessed at: http://gbgm-umc.org/umhistory/wesley/sermons/serm-050.stm
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