Do Socially-Responsible Mutual Funds Perform Better Than Conventional Mutual Funds - Research Paper Example

? Do Socially-Responsible Mutual Funds Perform Better Than Conventional Mutual Funds? Introduction Mutual funds are d to be an investment fund of different kind. Investment fund refers to the assortment of investments for instance bonds, stocks or other kind of funds. Mutual funds are significantly different from most of the different kinds of available funds. Mutual funds are described as ‘open-ended’ implying that as the number of people investing in the funds increases, the fund too increases its shares or units as well. However, mutual funds mainly concentrate on particular category of investments. For instance, a mutual fund might only invest essentially in large companies stocks, government bonds or even stocks of certain specific countries. Few of the mutual funds might chiefly invest in a combination of bonds as well as stocks or even in different mutual funds. Making investments in mutual funds have since long been considered to be safe as it combines an individual’s money with numerous different investors. This makes it possible for the venture to make different kinds of investments at a comparatively less cost. The other positive side of investing in mutual funds is that the investment decisions are made by a professional individual known as the manager (Ontario Securities Commission, 2009). Mutual Funds In simple words, it can be stated that mutual fund is a business which puts in funds in a branched out assortment of securities. The individuals purchasing a share or portion of the fund are considered to be the shareholders or owners. The investments made by these numerous individuals help the mutual fund company to acquire securities like bonds as well as stocks. The means of making money by a particular mutual fund from the securities that it invested in could be in two dissimilar approaches. Firstly, the mutual fund company could collect the interest or dividends paid on the security or secondly, the particular security could also increase in value. There also exist probabilities of losing money or experience a dip in value by a fund. Mutual funds could be classified into three usual kinds and they are the stock or equity, money and bond market. The stock funds refer to those which put in its funds principally in stocks that are issued by foreign or U.S. companies. The bond funds refer to those funds which principally invest in bonds. And the money market funds are the ones that chiefly make their investments in securities for the short-term. These securities are those that are made available in the market by the government and even its own agencies in the US, local as well as state governments and US corporations (Investment Company Institute, 2007). It needs to be mentioned in this context that there exists two different kinds of mutual funds and they are the socially-responsible ones and the other is the conventional or the traditional one. The socially-responsible funds involve certain decisive factors while making investments in companies. However, the traditional ones just take into concern the prospects and financial performance of the companies along with other relevant factors while investing (Statman, 2000). The process of selecting the right kind of investments takes a lot of expertise even in perfect market conditions. Along with choosing the appropriate investment there comes the necessity of keeping an eye on those investments made. Mutual funds make this process quite simple as there are experienced experts who control and supervise the assortment of securities all the time on behalf of an individual. In case of both the funds that is socially-responsible and conventional funds, an expert or a team of experts decide on the investment options after calculating the risk for each option (Investment Company Institute, 2007). It is a well known fact for proficient investors that the means of bringing down the degree of risk negatively influencing a particular investment is diversification of the investments made. Mutual funds are known to routinely bring in the concept of diversification in the investments by way of making it an assortment of investments and keeping a broad range of securities. It has been observed that there has been a trend in investing in socially-responsible mutual funds over the years. The investors of the conventional funds have been stated to be greatly concerned regarding the return generated by the funds and any alteration or decrease in the returns are addressed with discontentment towards the fund managers. The socially-responsible funds follow the similar dynamics but have significant point of differences. The investors of SRI funds tend to demonstrate a comparatively higher degree of trustworthiness towards their invested funds when it comes to inferior results. They are also known to show reduced degree of sensitiveness in terms of positive earnings (Veen, 2011). Mutual funds offer the advantage of diversification of investments as well as management by the experts at a much comparatively lower cost compared to independent investments (Investment Company Institute, 2007). Numerous studies have also brought to notice the fact that the trading behaviors of the conventional fund managers are quite different from the ones dealing with socially-responsible funds. The socially-responsible funds have been observed to usually demonstrate decreased rates of turnover as well return volatility. Therefore, it can be well understood that the performance of the fund managers are significantly different and are conducted in accordance with the preference of the investors (Veen, 2011). The other vital advantage offered by mutual fund is liquidity. Liquidity refers to the facility of accessing the invested amount. The shares of mutual fund are measured as liquid investments because of the reason that they come with the option of selling at any given business day (Investment Company Institute, 2007). Although the chief aim of mutual funds is to maximize the profits on the made investments. The performances of the conventional funds are heavily dependent on the choice of investments made by the fund managers. However, this is not same for the socially-responsible funds. The results of the investments in these socially-responsible funds are not possible to be credited to the choices of the fund managers as a host of other factors requires to be considered by them while making their decisions. These factors might not always prove to be advantageous for the investments (Kempf, 2005). The process of buying as well as selling of the shares of the fund is also quite convenient. The fund shares could be directly dealt in from the particular fund itself or via a bank, broker, insurance agent or financial planner. This could be carried out with the assistance of a number of ways like on telephone, by mail and even by accessing one’s personal computer. Mutual funds present the facility of periodic circulation as well as automatic reinvestment of the capital gains or the dividends that are rewarded to the investors on behalf of their investments made through the fund. The funds might also offer a broad range of different services which entails account statements that are provided quarterly or monthly, all time access to information regarding the fund as well as the account and tax related information (Nova Scotia Canada, 2011). The aim of mutual funds is to protect the investments and the interests of its investors. The funds are not just subject to observance with regard to their self obligatory limitations as well as restrictions but the funds are also extremely monitored with the help and assistance of the U.S. Securities and Exchange Commission (SEC). According to the guidelines specified by the government, all of the funds require to mandatorily meet up to particular operating specifications, reveal full information to the present and prospective investors and follow severely the regulations concerning antifraud. These mentioned regulations are stringently made compulsory and structured to safeguard the investors from falling prey to deception and exploitation. However, it is quite evident that these stated regulations can in no way assist in choosing the appropriate kind of fund or even stop a specific fund from incurring losses. It needs to be remembered that mutual funds are not guaranteed or even insured and so entails chances of even losing money (Investment Company Institute, 2007). Socially Responsible Mutual Funds Investors have witnessed quite a number of fraudulent actions along with unethical activities in businesses. These issues have made the investors quite anxious regarding negotiating their individual values in return of financial gain. It was found that there are numerous investors who were against the fact of their retirement being backed by activities that are considered unethical by them. Taking this concern into consideration, a form of investing known as ‘socially responsible’ way was initiated by the financial industry. Since the commencement of investing, there was the presence of few kinds of investors who had put in efforts to deal out their capital along with observing their values. There was an arrival of a particular kind of movement back in 19th century known as the ‘temperance movement’. This movement supported quite a number of different religious establishments and churches for the reason of shunning few of the supposed ‘sin stocks’ like gambling, alcohol and tobacco. In the era of 1960, the war rivals in Vietnam went ahead with few refusals against organizations dealing with weapons as well as the defense contractors (Young & Proffitt, 2003). In the period of 1971, the earliest mutual fund was founded which was considered as ‘socially responsible’. The fund was known as Pax World Fund and was established by two of the Methodist ministers. Socially responsible investing (SRI) was created in the period of 1980s when the world diverted its concentration on the apartheid performances in South Africa. Ever since that time, the amount of reasons supported by SRI started developing. Apart from the mentioned issues, an organization’s environmental record, their encouragement for or resistance to corporate governance performances, economic contribution towards the local society as well as charitable giving were all entailed in the chief SRI matters (Young & Proffitt, 2003; USSIF, 2011). Few of the funds are observed to adopt quite an active place in SRI, practicing ‘positive screens’ in their investment activities. Funds entailing positive screens look for involving companies that are known for its positive implementations like environmental confirmations, minority employing confirmations and also its association with the community. The other strategy entailed in SRI is the activism of the shareholder. The shareholder activism involves the investors to take part in management discussions, implement their respective alternatives and also selecting shareholder decisions in a way that is considered in harmony along with their own respective social values (Young & Proffitt, 2003; USSIF, 2011). Performance of Socially-Responsible and Conventional Mutual Funds It was found that both the socially-responsible and conventional mutual funds perform more or less in the same manner. However, at times it has been observed that the socially-responsible mutual funds have underperformed in comparison to the conventional funds. Investing in SRI would imply that the investor might need to forego few of the proceeds with regard to the screening of the SRI. The screening approach as well as the fund management is required to be investigated prior to making a selection of a fund. This might imply that few of the prospective and revenue earning companies might be excluded based on the screening specifications. Investors who are socially responsible demand assortments that are compliant with their beliefs as well as values. The profits related to the SRI have had an adverse experience owing to the present bear market. This has been mainly attributed to the combination of the investment decisions and not on the practice of screening investments activities. It has been stated in relation to the SRI mutual funds that the practice of screening activities with regard to investments incurs additional expenses for the funds. These additional expenses have been found to be transferred on to the customers of the fund which as a result negatively affects their net proceeds. The screening process most of the times deprive the investors of significant diversification advantages that are associated with the unscreened portfolios. However, because of the screening process the degree of systematic risk is observed to be a bit lesser in comparison to the average. There have been numerous studies conducted so as to ascertain the superiority of performance with regard to socially-responsible and conventional funds (Gil-Bazo, Ruiz-Verdu & Santos, 2008; Stenstrom & Thorell, 2007). There have been varying results which were obtained from these studies in this regard. However, it was found from the studies that the excellence associated with fund management had the potency to significantly influence the funds financial performance. The management of the SRI funds and the conventional funds would vary to a great extent for quite some reasons. The first point of variation would be in terms of purposes that need to be attained by the fund managers. Conventional fund managers would just pursue a single objective and that would be to attain the maximum possible proceeds to a particular risk return. Whereas, the fund managers associated with SRI would have several purposes to address. They not just need to make certain of attaining increased proceeds but also ensure that their chosen assortment of investment organizations are in accordance with the selected SRI screening. A point of disparity in the investor choices among SRI and conventional funds could likely have an influence on the requirement of performing well. Therefore, the choice that needs to be made by the fund managers in compliance with the SRI could pose an adverse consequence on the performance of the funds (Nakajima, 2011; Cox, 2009). Therefore, it can be said that both the socially-responsible and the conventional mutual funds perform in a more or less similar way. There are chances of reduction in the expected earnings of the socially-responsible assortments owing to cash inflows. The main disadvantage with regard to the socially-responsible mutual funds is that it might prevent investing in certain companies that are not considered to be ethical. These companies might have a strong potential of generating high proceeds. These kind of decisions at times might make the proceeds earned from the investments suffer. It was also reveled in certain studies that the socially-responsible mutual funds charge a comparatively higher fee because of the expenses related to the screening activities of the invested companies. However, it was found in certain studies that this was not true and there was not much of a difference in the fees charged by the socially-responsible and the conventional mutual funds. Thus, not much of a difference could be created or rather the return on the investment could be prevented from suffering much because of the significant difference in the fees (Nakajima, 2011; Cox, 2009). The other point of disadvantage with the socially-responsible funds is that these funds provide quite minimum chances of diversification because of the screening procedures. Diversification helps in distributing the risk related to the investment in the assortment of companies. Diversification ensures that not much loss is incurred if few of the companies where the investments are made fail to deliver the expected returns. Taking this fact into consideration, it could be stated that although the degree of risk associated with the socially-responsible mutual funds have been observed to be low but still the risk remains undistributed. This implies that in case if few of the companies underperform as a result of which the proceeds generated from the invested amount in those companies experiences a dip then it is likely to pose an adverse influence on the overall profits generated by the fund (Nakajima, 2011; Cox, 2009). Conclusion From the above discussion, it could be well understood that mutual fund investments are a way to earn additional revenues or rather make savings. Mutual funds are preferred and are considered to be less risky because of the fact that it gives the opportunity of making a variety of investments in different sectors at a reasonable cost. The option of making an assortment of investments helps in bringing down the degree of risk as well as evenly distributes the risk. The investment decisions are made by an expert and the related activities are monitored by that particular expert or a group of expert known as the fund manager. The fund managers work with the objective of making such investments which could earn them the maximum possible proceeds. In this regard it needs to be mentioned that apart from the conventional funds there are also funds that are considered and referred to as socially-responsible funds. These kinds of funds make their investment decisions based on specific screening specifications. These screening specifications might even prevent investing in a few of the potential companies or industries and also prevent diversification. However, these points have been observed to hardly differentiate the performance of these two funds. Both the funds have been found to perform in a similar way. References Cox, P. (2009). Responsible investing in fund management? It works, but when? University of Exeter, pp. 1-95. Gil-Bazo, J., Ruiz-Verdu, P., & Santos, A. P. (2008). The performance of socially responsible mutual funds: the role of fees and management companies. Retrieved from http://www.javiergilbazo.es/resources/GilbazoRuizverduSantos_SRfunds.pdf Investment Company Institute. (2007). A guide to understanding mutual funds. Retrieved from http://www.ici.org/pdf/bro_understanding_mfs_p.pdf Kempf, A. (2005). The effect of socially responsible investing on portfolio performance. Cenre for Financial Research, pp. 1-26. Nakajima, K. (2011). Socially responsible firms and stock returns: evidence from Japanese constitutions in FTSE4Good index. Nikko Financial Intelligence, Inc., pp. 1-9. Nova Scotia Canada. (2011). Mutual funds what you need to know. Retrieved from http://www.gov.ns.ca/nssc/docs/MUTUALFUND.pdf Ontario Securities Commission. (2009). Understanding mutual funds. Retrieved from http://www.osc.gov.on.ca/documents/en/Investors/res_mutual-funds_en.pdf Statman, M. (2000). Socially responsible mutual funds. Association for Investment Management and Research, pp. 30-39. Stenstorm, H. C., & Thorell, J. J. (2007). Evaluating the performance of socially responsible investment funds: a holding data analysis. Retrieved from http://www.responsible-investor.com/images/uploads/resources/research/21205478981Evaluating_the_performance_of_SRI_funds.pdf USSIF. (2011). Socially responsible investing. Retrieved from http://ussif.org/resources/factsheets_resources/documents/10mediaquestions_FINAL.pdf Veen, M. F. (2011). The risk shifting behavior of socially responsible mutual fund managers. Maastricht University, pp. 1-95. Young, K., & Proffitt, D. (2003). Socially responsible mutual funds: recent performance and other issues relating to portfolio choice. Retrieved from http://www.cbfa.org/Young.pdf Read More