Is Ethical Money Financially Smart?

Abstract

Little is known about how investors select socially responsible investment (SRI) funds. Investors in SRI funds may care more about social or ethical issues in their investment decisions than about fund performance. This paper studies the money-flows into and out of the SRI funds around the world.We find that ethical money chases past returns. In contrast to conventional funds' investors, SRI investors care less about the funds' riskiness and fees. Funds characterized by shareholder activism and by in-house SRI research attract more stable investors. Membership of a large SRI fund family creates higher flow volatility due to the lower fees to reallocate money within the fund family. SRI funds receiving most of the money-inflows perform worse in the future, which is consistent with theories of decreasing returns to scale in the mutual fund industry. Finally, funds employing a higher number of SRI screens to model their investment universe receive larger money-inflows and perform better in the future than focused funds.Keywords: money-flows, ethical funds, socially responsible investing, persistence in performance, investment screens, corporate governance screens, SRI JEL classification: G10 and G19 2 "Invest with your brain and heart. Invest for our planet… The Funds give investors the ability to unite their financial goals with environmental progress" --from the prospectus of Sierra Club Funds Particular to the socially responsible investment (SRI) funds, often also more narrowly called ethical funds, is that both financial goals and social objectives are pursued. Over the past decade, these SRI funds experienced a tremendous growth in most developed economies around the world. 1 SRI comprises assets under management worth $2.1 trillion, representing approximately 11% of the total assets under professional management in the US (Social Investment Forum, 2003). 2 This paper studies the money-flows into and out of the SRI mutual funds around the world.Some recent studies on the behavior of investors in mutual funds show that both financial and nonfinancial fund attributes affect the choice of a particular mutual fund or hedge fund. Risk-adjusted as well as raw past performance significantly affect the money-flows of mutual funds (see, e.g. , 1997;Goetzmann and Peles, 1997;Sirri and Tufano, 1998;Del Guercio and Tkac, 2002). While the top performing mutual funds attract most of the inflows, the weakly performing funds are hardly affected by outflows. This indicates that once money is invested, it tends to be rather sticky (Gruber, 1996). Furthermore, non-financial attributes like mutual fund visibility (Sirri and Tufano, 1998) In spite of the fact that SRI has become a multi-trillion dollar market, little is known about how investors select funds with explicit non-financial attributes. 3 Investors in SRI mutual funds may 1 The terms SRI funds and ethical funds are often used interchangeably, although strictly speaking ethical funds are a subset of SRI funds. The latter comprise funds whose investment univer...