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Performance of Portfolios Composed of British SRI Stocks

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Abstract

This study investigates performance of portfolios composed of British socially responsible investments (SRI) stocks. Using the ‘Global-100 Most Sustainable Corporations in the World’ list (known also as ‘Global-100’) to select the SRI companies, we found that, in the period 2000–2010, the returns of the SRI portfolios were on average higher compared with the corresponding returns of the market indexes. The annual average difference in returns of the SRI portfolios (with dividends) was 5.26 % and 5.69 % relative to the FTSE100 and FTSE4GOOD indexes (the total return versions), respectively, but the differences in returns in the whole period, in individual years and in other sub-periods were in most cases not statistically significant. Positive performance of SRI stocks in the whole sample is, however, evidenced by risk-adjusted measures such as the modified Sharpe ratio (MSR) and certainty equivalent (CEQ) returns, as well as by incorporating various levels of transaction costs. Furthermore, a simple trading strategy relying on selection of SRI stocks from the Global-100 list would beat the market indexes in the whole period 2000–2010, even after inclusion of various levels of transaction costs. We also estimated the Fama–French and Carhart multi-factor models and found that the returns of the SRI portfolios cannot be consistently explained by conventional factors other than the market factor.

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Notes

  1. The first ethical unit trust in the UK was the Friends Provident Stewardship Fund launched in 1984 (Cowton 1993). This and similar funds have used ‘the investment process as a means to change and improve the behaviour of specific corporations on social and environmental issues’ (Louche and Lydenberg 2012, p. 6).

  2. When constituents of the list are analysed by country, it is apparent that the country allocation was being updated over time. For example, at the time of the list being announced in 2005, Royal Dutch Shell was considered to be Dutch, however after the updates it is later listed as the UK firm. The same effect has occurred for several other companies. When this was the case, we have edited the countries to best reflect the Global-100 list at the time of data collection.

  3. The motivation of this study is the analysis of performance of portfolios that can be constructed by private investors based on the freely available information from the Global-100 list and because it is unlikely that such investors would engage in detailed investigations of stock size and their capitalisation, etc., this is also the reason why we assume that they would usually construct simple equally-weighted portfolios.

  4. The source of risk-free rate data in the Xfi database is the return of the 3-month UK T-Bill.

  5. Certainty equivalent (CEQ) returns are used in our study as an additional risk-adjusted measure to differentiate between risk-adjusted returns for various possible groups of investors and for their respective risk aversion levels, which naturally always vary among stock market participants (depending on many factors, such as level of wealth, aim of the investment in stocks, personal circumstances, etc., among other things). Hence, the CEQ measure is very useful as an additional method of evaluation of investment results in comparison with more traditional measures, such as Sharpe ratio or Treynor index, which by definition do not offer any possibility to take into account risk aversion of investors in an analysis of stock market returns. Given that the motivation of this study is the investigation of performance of SRI stocks portfolios that can be constructed by private, individual, investors (based on the freely available information in the form of the Global-100 list), the analysis of the CEQ returns is particularly important because of the fact that individual investors have a very broad range of risk aversion levels (much broader than institutional investors) which extends far to both sides of risk aversion interval (from very risk-averse people who make investments of their private funds for, e.g., retirement to very highly speculative individuals).

  6. The average annual geometric returns were calculated using the definition: ((1 + r 1) × (1 + r 2) × (1 + r 3) × ··· (1 + r n ))(1/n) − 1, where r 1, r 2, r 3,…, r n are annual returns. For example, in Table 2a, the average annual geometric return for the 5-year period 2000–2005 for the SRI portfolio is equal to 10.20 % and it was computed as: ((1 + 0.2422) × (1 − 0.0245) × (1 − 0.2081) × (1 + 0.3665) × (1 + 0.2393))(1/5) − 1 = 0.1020 (i.e. 10.20 %).

  7. We also calculated MSR for the two other variants of comparisons related to results in Tables 2b and 2c. These results are not reported here because of space constraints, but are available on request. When the SRI portfolios (with dividends) are compared against the price version of the indexes, they performed better than both FTSE100 and FTSE4GOOD also in seven out of ten single-year periods and, in addition, in all 5-year multiple-year periods and most other sub-periods. The advantage of SRI slightly declines on the like-to-like comparison basis for variants of SRI portfolios and indexes without dividends, but the overall pattern is similar to the results in Table 3. In any case, the modified Sharpe ratio (MSR) for the entire period is always higher and remains positive for SRI portfolios in all three cases of comparisons (0.0627 and 0.0082 for the variants of the SRI portfolios with and without dividends, respectively), while for both indexes FTSE100 and FTSE4GOOD, it has only negative values of −0.0001 and −0.0002 (for the total return and price index versions, respectively). The comparison of SRI portfolios results with price index versions of the indexes may be relevant whenever they are used as commonly accepted market benchmarks (rather than their total return versions).

  8. Similar pattern of results for the CEQ measure was found for the two other variants of comparisons related to results in Tables 2b and 2c. It shows higher values of CEQ for SRI portfolios in most single-year and multiple-year sub-periods with a declining advantage over the indexes for higher risk aversion levels of the investors. These results are not reported here due to space constraints, but are available on request.

  9. Alternative possibility to deal with time variation of beta is to estimate conditional CAPM versions of the Fama–French and Carhart models; however, this methodology has been criticised because of various shortcomings (see, e.g., Lewellen and Nagel 2006; Lewellen et al. 2010) and, therefore, we opted for a more straightforward analysis of beta estimates in sub-samples.

  10. The parameters of all models in shorter sub-periods for individual years (or other shorter length periods) were estimated using: 12 monthly observations for the shortest annual periods, 60 monthly observations for the 5-year multiple periods and 61, 59, 41 and 79 monthly observations for the bull market, bear market, economic growth and recession periods, respectively.

  11. Similar conclusions are reached when instead of estimation of models in shorter sub-samples, we used dummy variables for the analysed sub-periods.

  12. These results are not reported here in details due to space constraints, but are available on request.

  13. The pattern of betas is also very similar to the results from both Fama–French and Carhart models when beta is estimated using a simple single-factor model (estimation results are not reported but are available on request).

  14. Although the small stocks effect is unlikely to be strong and materially change the overall picture which emerges from our results, we did more analysis of the small versus large stock returns and we found that when the portfolios beat the market the smaller stocks (i.e. those which are included in the Global-100 list but not in the FTSE100 index) have on average greater than the portfolio returns and when the portfolio is underperforming the market these smaller stocks are further underperforming. This means that the size effect would manifest itself, if the portfolios were capitalisation-weighted, in weaker outperformance of the SRI portfolios relative to the indexes in the periods of the SRI portfolios overperformance but also weaker underperformance in the periods when the SRI portfolios underperformed. As mentioned earlier, those effects are not likely, however, to be very strong because of the selection criteria of the Global-100 list, which is composed of mainly large stocks.

  15. For example, the Global-100 has a 75 % weighting to a company’s USD sales to Gigajoules of total energy consumed ratio (3-year average) under the energy productivity area (Global-100 2011). Similar use of ratios is made within the other areas listed above. The FTSE4GOOD, for example, requires a high impact company under the environmental area to have in place a ‘policy [that] must cover the whole group and either: meet all five core indicators plus one desirable indicator, or meet four core plus two desirable indicators’ (FTSE International Limited 2010).

  16. These calculations are based on monthly figures from the whole period of portfolio’s duration (i.e. 1 year between February and January in the following year). Because of space constraints, they are not reported here, but are available on request.

  17. We used the definition of independent variables as a ratio of DY indicators rather than a simple difference because of larger percentage variation of data in case of the ratio relative to the difference. However, we estimated also variants with differentials of DY ratios and the conclusions were quite similar, i.e. the estimates had positive signs but they were on the borderline of statistical significance (of 10 % level).

Abbreviations

CAPM:

Capital asset pricing model

CEQ:

Certainty equivalent returns

CFP:

Corporate financial performance

CSP:

Corporate social performance

CSR:

Corporate social responsibility

DY:

Dividend yield

GBP:

British pound

LSE:

London Stock Exchange

MSR:

Modified Sharpe ratio

PE:

Price-to-earnings ratio

PI:

Price index

SR:

Socially responsible

SRI:

Socially responsible investments

TRI:

Total return index

USD:

US dollar

WEF:

World Economic Forum

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Acknowledgments

We wish to thank two anonymous referees for excellent comments on this paper as well as David E. Harris from FTSE Group for data and discussion about FTSE4GOOD index and Doug Morrow from Corporate Knights for information about Global-100 list. We are also very grateful to David Cobham for a discussion about dating business cycles in the UK, Moh Sherif for a discussion about conditional CAPM methodology and Alan Gregory and Rajesh Tharyan from Xfi Centre for Finance and Investment at the University of Exeter for information and data for the Fama-French and Carhart models for the UK market.

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  1. Department of Accountancy, Economics and Finance, Heriot-Watt University, Edinburgh, UK

    Janusz Brzeszczyński & Graham McIntosh

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  1. Janusz Brzeszczyński
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  2. Graham McIntosh
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Correspondence to Janusz Brzeszczyński.

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Brzeszczyński, J., McIntosh, G. Performance of Portfolios Composed of British SRI Stocks. J Bus Ethics 120, 335–362 (2014). https://doi.org/10.1007/s10551-012-1541-x

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