CFA Institute Journal Review 15 November 2018 Volume 48 Issue 11
Why Do Investors Hold Socially Responsible Mutual Funds? (Digest Summary)
Journal of Finance
Analyzing incentives behind socially responsible investment (SRI), the authors find that intrinsic social preference and, to a lesser extent, social signaling are important factors explaining SRI decisions. Financial motives play less of a role, and risk perceptions are irrelevant in SRI decisions.
How Is This Research Useful to Practitioners?
Intrinsic social preference, referring to the importance of such motives as altruism behind investment decisions, plays a dominant role in determining whether investors hold socially responsible investments (SRIs), but it is less relevant to the invested percentage. An investor with high social preference is 14% more likely to hold SRIs compared with a selfish investor. This result is economically significant; only 16% of investors in the authors’ sample hold SRIs.
Social signaling also matters: Regression results show that investors are 2.3% more likely to hold SRIs with one point higher on the signaling variable. For investors holding SRIs for social signaling purposes, SRIs represent a significantly smaller share in the portfolio.
Financial incentives play a role but are unlikely to be the main motivation behind SRI. Realized portfolio returns for socially responsible investors are similar to those of conventional investors. SRI funds incur more expenses (2.2% for SRI versus 1.5% for non-SRI) and generate significantly lower performance (including risk-adjusted measures) compared with other investments in an SRI investor’s portfolio. Survey responses show that only 16.5% (14.5%) of socially responsible (conventional) investors expect a higher return on SRI but 48.7% (56.1%) expect a lower return from SRI. Regression results indicate that investors do not hold SRI equity funds to pursue higher performance. Investors who expect SRI to underperform are 5.8% more likely to avoid such funds.
Risk perception is unrelated to SRI decisions. Only 5.4% of socially responsible investors claim diversification benefits as a reason to hold SRI in their portfolios.
SRI is not a substitute for charitable donations. The correlation between SRI and such donations is found to be significantly positive rather than negative.
Other (marginally) statistically significant findings are that compared with traditional investors, socially responsible investors have a longer investment horizon and a larger portfolio and are more likely to be active investors. In terms of individual-level characteristics, a socially responsible investors tends to be younger and more likely to have an advanced degree.
How Did the Authors Conduct This Research?
The authors construct a survey with incentivized experiments and link responses with administrative data from a major mutual fund provider in the Netherlands.
A group of 3,382 investors (16.2% of the sample) who hold at least one SRI in their portfolios are identified as socially responsible investors. Conducted in June 2011, the survey was sent to both the SRI group and a group of 32,000 randomly selected conventional investors (out of approximately 145,000 remaining accounts in the database). The response rate was 12% for the former group and 8% for the latter.
Survey participants’ risk preferences are reflected by their switching point between a lottery and a certain income; social preferences are elicited from a controlled and anonymous one-off trust game experiment in which the behavior of the second mover serves as a measure of intrinsic social preferences. The social signaling variable is captured by surveying whether participants often talk about SRI to others.
A regression analysis is conducted to examine the factors that influence SRI decisions while controlling for a group of portfolio and individual investor characteristics. Intrinsic social preference is distinguished from social signaling. Both factors appear to be statistically significant, but social signaling is less so. Only a negative parameter related to expected returns on SRI is statistically significant (an investor is 5.8% less likely to hold an SRI if she expects it to underperform). Risk perception dummies are not significant.
Additional regressions are conducted to check the robustness of findings.
A growing number of investors demand SRI choices, which exclude “sin” portfolios and focus on companies that benefit society. Much SRI-related research explicitly or implicitly assumes social preference as a dominant rationale for investors to hold SRIs. A broad feeling of strong prosocial preference seems apparent, but the exact incentives remain ambiguous and other explanations remain possible.
The authors create a unique dataset by combining administrative data with responses from a well-designed survey. They specifically distinguish between intrinsic social preference and social reputations. The use of the second mover’s behavior from the trust game provides a clean and independent measure of social preference.
The authors shed light on ways to explore motivations. They provide empirical support for key assumptions in many SRI-related studies and contribute to asset pricing studies. Because SRI has been rising steadily in popularity among investors, the effect of social preference may put more upward price pressure on socially responsible investors and downward pressure on sin companies.
The data have some limitations; this sample includes only Dutch investors and focuses on SRI equity funds. The measures of financial motives and social signaling are from the survey data, which are less clean than social preferences derived from the incentive experiment. Moreover, asking correspondents whether they often talk about SRI is not a clean measure of social signaling. Further (laboratory-based) research may better test the robustness of this result.
Marginally significant findings related to portfolio and individual characteristics in this study need to be treated carefully because they may be self-enforcing. For example, a man with a university degree may be more likely than other individuals to be in charge of a larger fund—the type that is more likely to have space for SRI.