Socially Responsible Investment - September 22, 2011

Performance of Socially Responsible Investment Funds against an Efficient SRI Index: The Impact of Benchmark Choice when Evaluating Active Managers

Performance measurement of socially responsible investment (SRI) has been the subject of numerous studies in various countries. However, the conclusions of performance assessments always depend on the choice of the reference index one uses. SRI criteria lead to a reduction of the stock universe. Typical SRI indices respect such screenings and then simply weight the acceptable stocks by market cap, or alternatively by sustainability scores. They thus ignore the risk/return properties of stocks and in particular the correlations. Consequently, they do not necessarily reflect the performance available from a well-diversified portfolio of SRI-compliant stocks.

Efficient SRI indices on the other hand, apply an optimal weighting scheme to the screened universe. They thus constitute a relevant proxy for the performance that is achievable through a sole focus on improving diversification within an SRI universe. In that sense they constitute a useful yardstick for active SRI funds from which investors would at least expect improved diversification, if not additional value added through stock picking. Given that such efficient SRI indices are also easy to replicate at low cost, they constitute investable alternatives to actively managed funds, and are thus relevant for practical comparisons of performance.

This paper conducts a performance measurement of SRI funds and assesses the impact of changing the reference from a standard SRI index to an efficient SRI index. The analysis of fund performance shows that an efficient SRI index raises the bar for actively managed SRI funds. While about 60% of funds have a positive information ratio when compared to the cap-weighted EuroStoxx Sustainability Index, only about 25% of funds do so with respect to the Efficient SRI Index. It is also interesting to note that the median information ratio across funds is slightly positive (0.05) when using the standard SRI index, but it is clearly negative (-0.22) when using the Efficient SRI index.

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