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The Price of Ethics: Evidence from Socially Responsible Mutual Funds

ECGI - Finance Working Paper No. 168/2007

TILEC Discussion Paper No. 2007-012

CentER Discussion Paper Series No. 2007-29

51 Pages Posted: 10 May 2007 Last revised: 2 Sep 2014

Luc Renneboog

Tilburg University - Department of Finance; European Corporate Governance Institute (ECGI); Tilburg Law and Economics Center (TILEC)

Jenke ter Horst

TIAS School for Business and Society

Chendi Zhang

University of Warwick - Finance Group

Date Written: May 1, 2007

Abstract

This paper estimates the price of ethics by studying the risk-return relation in socially responsible investment (SRI) funds. Consistent with investors paying a price for ethics, SRI funds in many European and Asia-Pacific countries strongly underperform domestic benchmark portfolios by about 5% per annum, although UK and US SRI funds do not significantly underperform their benchmarks. The underperformance of SRI funds does not seem to be driven by the loadings on an ethical risk factor. SRI funds do not suffer a cost of reduced selectivity nor do SRI funds managers time the market. There is mixed evidence of a smart money effect: SRI investors are unable to identify the funds that will outperform in the future, whereas they show some fund-selection ability in identifying ethical funds that will perform poorly. The screening activities of SRI funds have a significant impact on funds' riskadjusted returns and loadings on risk factors: corporate governance and social screens generate better risk-adjusted returns whereas other screens (e.g. environmental ones) yield significantly lower returns.

Keywords: ethics, mutual funds, socially responsible investing, investment screens, smart money, risk loadings

JEL Classification: G12, G34, A13, Z13

Suggested Citation

Renneboog, Luc and ter Horst, Jenke and Zhang, Chendi, The Price of Ethics: Evidence from Socially Responsible Mutual Funds (May 1, 2007). ECGI - Finance Working Paper No. 168/2007; TILEC Discussion Paper No. 2007-012; CentER Discussion Paper Series No. 2007-29. Available at SSRN: https://ssrn.com/abstract=985265 or http://dx.doi.org/10.2139/ssrn.985265

Luc Renneboog

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Warandelaan 2
5000 LE Tilburg
Netherlands
+13 31 466 8210 (Phone)
+13 31 466 2875 (Fax)

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Tilburg Law and Economics Center (TILEC)

Warandelaan 2
Tilburg, 5000 LE
Netherlands

Jenke R. Ter Horst

TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Chendi Zhang (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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