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  • Writer's pictureEvelyn Chen

Returns from Socially Responsible Businesses

I recently inherited some money from a relative and decided to spend £1,000,000 of that on investments. I decided to invest in a socially-responsible manner because I want to help others whilst improving my financial situation. I was also curious about whether socially-responsible investing could be profitable for the investor and to test that, I compared the performance of my portfolio against the FTSE 100’s performance from 22/02/21 to 19/04/21.

There is evidence to show that companies that adhere to socially-responsible values outperform the ones which don’t. This is because firms that neglect such responsibilities are more likely to encounter problems resulting in financial loss. For example, environmentally unfriendly firms are more likely to experience the costly settlements of environmental lawsuits, rendering them less profitable as a result. Díaz at al. (2021) found that ESG (environmental, social, and governance) criteria’s impact on firms in most industries is mainly due to the environmental and social aspects. Therefore, firms scoring highly in certain aspects of ESG factors are more able to mitigate stakeholder-related risks, particularly in times of financial crisis such as the Covid pandemic we are experiencing now (Díaz et al.,2021).

As a result, I used financial data firm Refinitiv’s ESG Environmental and Social Pillar scores to shortlist my stocks; I chose the 50 highest scoring stocks. I excluded firms in the airline industries because airlines are not going to grow until most lockdown restrictions are lifted and demand for air travel returns. I excluded firms in the consumer discretionary industry because consumer discretionary is the only sector affected negatively by all ESG aspects (Diaz et al., 2021).


Table 1: Equities picked using the Pillar scores from Refinitiv




Table 2: My portfolio’s relative vs absolute returns




The positive relative return 0.7291% shows that my portfolio has outperformed the benchmark.


However, there may be other reasons why my portfolio has outperformed the benchmark during this period. One of the largest barriers to outperforming the benchmark is taxes. Investors lose a significant percentage of their profit when tax is paid on investment returns. The UK’s Capital Gains Tax starts at 10% and can increase to 20% for stocks. Therefore, because my portfolio was not affected by taxes in this scenario, my portfolio had a better chance of outperforming the benchmark.


Another barrier is behavioural bias. Fear leads to people selling low when the market drops whilst herd mentality leads to people buying high when the market does well. By rebalancing my portfolio (Baker and Ricciardi, 2014) and using a socially-responsible investing strategy, which is a strategy proven by a great deal of empirical evidence (Do, 2021), I avoided many behavioural biases and so had a better chance of outperforming the benchmark.

Moreover, my risk-aversion level is quite low, leading to my portfolio being exposed to more risk. My greater tolerance of risk might have led to my portfolio outperforming the benchmark, as more risk leads to more return (Merton, 1973). Regardless of the other factors, empirical evidence shows that portfolio performance is based more on luck than skill (Fama and French,2021). Therefore, the main reason why I outperformed the benchmark might be luck.

Nevertheless, investing in socially-responsible businesses is a promising idea that needs to be explored more both by academics and investors.


 

References


Baker, H.K. and Ricciardi, V. 2014. How biases affect investor behaviour. The European Financial Review, pp.7-10.

Díaz, V., Ibrushi, D. and Zhao, J., 2021. Reconsidering systematic factors during the

Covid-19 pandemic – The rising importance of ESG, Finance Research Letters, Chapter 38, pp. 101870. doi: 10.1016/j.frl.2020.101870.

Do TK., 2021, Socially responsible investing portfolio: An almoststochastic dominance approach. Int J Fin Econ. Vol.26, pp.1122–1132.

Fama, E. and French, K., 2021. Luck versus Skill in the Cross- Section of Mutual Fund Returns. In: Cochrane, J. and Moskowitz, T. ed. The Fama Portfolio. Chicago: University of Chicago Press, pp. 261-300. https://doi.org/10.7208/9780226426983-014

Jacob, N.L.,1971. The Measurement of Systematic Risk for Securities and Portfolios:

Some Empirical Results. The Journal of Financial and Quantitative Analysis, 6(2),p.815. Johnson, B., 2021, Morningstar’s Active/Passive Barometer [online] Available at: https://www.morningstar.com/content/dam/marketing/shared/pdfs/Research/active-passi vebarometer/Active_Passive_Barometer_2021_03_FINAL.pdf [Accessed 1.05.21] Merton, RC., 1973, An intertemporal capital asset pricing model, Econometrica: Journal of the Econometric Society, 41(5), pp.867–887.

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