How does investment on goods impact the risk of portfolio?

Question

I really need good references to see what the impact of SRI (socially responsible investment) is on the portfolio risk. I have searched through a lot of books but nothing I found. Can you please give me some information and references?

Answer 1

Imagine any mutual fund or ETF. They have an investment philosophy. It may be a combination of: growth, value, national, international, sector focused, broad based, equities, small, medium , large, government bonds, corporate bonds, junk bonds...

They also have an algorithm to decide which options within that philosophy make sense. That is how they decide which of the thousands of opportunities within their philosophy make sense to buy or sell.

Socially responsible investment is just another philosophy/algorithm. Does it help or hurt? Nobody can know in advance. This year it may have been a winner (or a loser) next year the opposite may be true. The best algorithm in the world may not turn a fund into a winner, if the section of the total market they focus on is a poor performer. Then again a poor algorithm may hurt performance.

You have to decide if the returns you are seeing with the fund is acceptable to you, based on your motivation for wanting to use socially responsible investing as a criteria.

Answer 2

SRI try to invest in companies that do ‘good’ and avoid companies that do ‘bad’ for some meaning of ‘good’ and ‘bad’.

When investing in small companies there are so many to choose from that focusing on a subset that is doing ‘good’ that not restrict the choose of the fund manger too much. Also lots of ‘good’ things, like reducing power usage also tend to lead to more long term profits.

However when you look at big companies, each of them do lots of different things, so are often excluded from considering due to one ‘bad’ think a small part of the company does. For example a building company may be excluded as they built one small building for an arms company.

All investment managers should think about SRI (socially responsible investment) as part of a risk of any investment is that the company may become unliked due to something it is doing and hence targeted by law makers.

But SRI funds have clearly defined rules about how they consider SRI issues, as these rules are different for each fund, and the funds invest in different segments, it is very hard to see what effect the SRI rules have had on the returns.

Answer 3

There is a Finnish company Seligson that changed their index funds to follow socially responsible indexes instead. They did a comparison of these socially responsible indexes with other indexes. The conclusion was that both volatility and return were practically unchanged. Unfortunately, Seligson's material is available only in Finnish, so most readers here probably don't understand it. Because the volatility was practically unchanged, it can be concluded that the portfolio risk does not change, assuming that the socially responsible indexes are otherwise well-diversified.

You could speculate that socially responsible investing avoids some of the risks of non-socially responsible investing, so the risk should be lower. You could also speculate that socially responsible investing leads to poorer diversification (since you lack the diversification to non-responsible companies) and thus to greater risks. However, all that is just speculation. The only fact is historical volatility which is practically identical for well-constructed indexes.

Whatever you do, don't let the costs in a socially responsible portfolio rise to higher values than in non-responsible portfolio. Costs are the only thing that is certain in investing, and if you increase costs, you can be certain that you decrease your future returns by the same amount.