August 01, 2003
Critics Find Study of SRI Underperformance Fundamentally Flawed
by William Baue
A recent Wharton School study that finds underperformance by socially responsible investment mutual
funds is based on an unsound research design, according to critics.
A recent study from the Wharton School
of the University of Pennsylvania purports that portfolios containing socially responsible
investment (SRI) mutual funds underperform portfolios representing a broader fund universe. The paper,
entitled Investing in Socially Responsible Mutual Funds, considers fund managers'
stock-picking skills, and employs such sophisticated analytical techniques as the Sharpe ratio and
the Capital Asset Pricing Model (CAPM). Critics of the study point to the study's potential design
flaws, as well as to other current studies being added to the already-large body of empirical studies that demonstrate the competitive
performance of SRI funds.
"This study makes several elementary mistakes," said
Richard Torgerson of the Financial West Group and a registered principal in the Progressive Asset Management (PAM) network. "First
and foremost, the universe selected to compare SRI funds against actually undercuts their entire
The study, authored by Wharton professors Christopher C. Geczy and Robert F.
Stambaugh and graduate student David Levin, uses 46 different non-SRI mutual funds from a universe
of 894 equity mutual funds. The authors then constructed 36 different portfolios of varying
allocations to reflect various decision-making models.
"Fully 50 percent of the 46 non-SRI
funds making up the portfolios compared against SRI portfolios are completely unavailable to the
average mutual fund investor, either by having investment minimums above $100,000 or by being
closed to new investors at the time the study was done," said Mr. Torgerson. "None of the 36
portfolios constructed by Geczy, Stambaugh and Levin were constructed with any less than 44 percent
of the portfolio consisting of unavailable funds."
"Five of the 36 portfolios were made up
100 percent of unavailable funds," Mr. Torgerson added. "So in effect, the Wharton study urged
investors to eschew SRI funds in favor of other funds that they can't invest in."
the three Wharton authors responded to SocialFunds.com's requests for their commentary.
Interestingly, Innovest Strategic Value
Advisors criticized the study on a related but distinct aspect.
"At one point, the
Wharton study compares the performance of broadly-based SRI funds with a group of 28 mainstream
equity funds, of which fully 17 are real estate funds!" said Bijan Foroodian, director of
quantitative analysis at Innovest. "Given the enormous differentials in the risk/return
characteristics of these two different types of investments, this comparison is, at best,
Mr. Foroodian authored a recent Innovest report that examined SRI
simulations of a U.S. public pension fund. Five out of six simulations outperformed the actual
portfolios throughout 2002 by an average of 100 basis points, or one percent. The simulations were
different only in that they were tilted according to Innovest's EcoValue'21 ratings, which identify
environmental best practice. The sole underperforming simulation did so only by .04 percent.
The pension fund that served as the model employs the EcoValue'21 overlay on an actual
$150 million portfolio. That portfolio outperformed its S&P 500 benchmark by 1.5 percent in the
year since its inception in March 2002.
Recent performance also may undermine the study's
own conclusions regarding its comparisons. For example, one scenario compares an SRI portfolio
comprised of the California Mid Cap Index (ticker: SPMIX), the Citizens Core Growth (WAIDX),
and the Domini
Social Equity (DSEFX) funds to a non-SRI portfolio totally allocated to the Vanguard Total
Market Index Institutional (VITNX) fund. The study finds that the latter portfolio outperformed
the former by five basis points per month up through December 31, 2001.
out the apples-to-oranges comparison of an institutional fund to three retail funds, Mr. Torgerson
discussed his analysis of the portfolios' performance from the end of 2001 through June 30, 2003.
"The portfolio that was supposedly given a 5 bps advantage by Sharpe ratio measures
actually underperformed the SRI portfolio by 3.16 percent," Mr. Torgerson stated. "Their own
portfolio selection this instance shows about a 16 bps monthly advantage to the SRI portfolio
instead of the 5 bps penalty predicted by the December 31, 2001 Sharpe ratio."