Socially Responsible Mutual Funds and Conventional Mutual Funds - Research Paper Example

?Do socially responsible mutual funds perform better than conventional mutual funds? Do socially responsible mutual funds perform better than conventional mutual funds? Introduction For many years, socially responsible investment also known as ethical investment has grown tremendously all over the world. Socially responsible investment is a process that incorporates ethical, social, and environmental considerations into investment decision-making criteria. Unlike the conventional investment, socially responsible investment funds apply a set of investment checks or screens to exclude or select assets based on ethical, social, ecological, or corporate governance criteria. In addition, it includes incorporation of local communities in order to further its aim to achieve its goals (Schepers, 2009). Socially responsible investment has for years been viewed as the practice for individuals who are interested in social change and who aim to yield much profit at the end. There was a time when it was hard or difficult to establish a socially responsible portfolio that was competitive on market because the socially responsible investing universe was not large. But that is the past since time have changed in that in modern day there are more than 100 mutual funds that incorporate social screens in their management decisions which aim to improve their profits. Investors are in a position to create portfolio that is competitive and real to their social concerns. In addition, there exist more direct investment opportunities such as buying certificates of deposits with local or community banks (Vogel, 2006). Mutual funds Mutual funds are said to be investment capital of distinct type. In this regard, investment fund refers to the variety of investments such as stocks, bonds and other types of funds. Mutual funds are different from most of distinct types of funds present. In this sense, mutual funds are referred to as open-ended meaning that as the number of people investing in the funds rises, the funds also increases its units in the market. Mutual funds concentrate on specific category of investment such as large firms stocks and government bonds of certain Nations. In addition, few of the mutual funds might slightly invest in combination of stocks and bonds in distinct mutual funds. For many years, investing in mutual funds has been viewed as safe mode of investment as it incorporates both individual capitals with many different investors, which makes investors to invest in different types of investment at less cost (Renneboog et al 2008). There are two different types of mutual funds investment namely; socially responsible mutual funds and conventional mutual funds. The socially responsible mutual funds involve certain factors to consider while making decision concerning the firm to invest in. Socially responsible funds perform better because the funds apply their ownership rights to manipulate management via policy alteration or change suggestions. They ensure that this advocacy is attained through attending shareholders meetings, exercising voting rights in companies, writing letters to top management, and filing proposals. In most scenarios, it is very hard for shareholders to hold and exercise their voting rights. Therefore voting are attained via proxy. Many investors advocate socially responsible funds because they have strict policy that aim to maintain transparency in decisions and disclose all proxy voting procedures, policies and conducting voting rights of its shareholders (Schepers, 2009). On the other hand, the conventional mutual funds is concerned with the prospects and financial performance of firms combined with significant factors while investing. Discussion Over the years, there has been a tremendous increase in the number of socially responsible mutual funds. The issue of social investment has been subject of debate for many years. However, the modern manner of investment has been because of financial crisis that began in 1930s. At that time, there were many issues available in the political arena ranging from civil rights movements, environmental awareness to use of nuclear energy. These issues led to investment managers and other investors to shift focus to social awareness, which ensured that any form of investment was to be ethical. This awareness led to establishment of ethically managed investment funds that has been on the rise and represent large amount of capital invested in major industrialized nations like Britain, France, US and Russia. It is said that more than 10% of funds that are being managed are part of socially responsible funds (Schepers, 2009; Renneboog et al 2008). There is increasing amount of capital being invested ethically which has made researchers to determine whether socially responsible mutual funds is the best approach for investors than the conventional mutual funds. It has been held initially that, socially responsible mutual funds did not invest widely and deeper into markets as conventional approach. Critically, when the two methods are compared, there is slight difference of capital earned as profit by conventional and social approaches. It is apparent that the two forms of investment mutual funds do not follow a specific pattern in their investment criterion if analyzed from developed countries perspective. However, when socially responsible mutual funds are analyzed according to investment in small firms in developing countries with conventional approach, discrimination is detected in that the ethical form of investment outperformed conventional method and earned much returns than conventional strategy among small firms operating in developing Nations. Socially responsible mutual funds Research conducted by Vogel (2006) aimed to wipe out the tribulation of the benchmark that was placed on small firms and investment by socially responsible mutual funds. In the research, he considered the size of social fund and the exact date it was established. They applied Jensen alpha statistical method to analyze their findings. He stated that social funds outperformed other funds and yielded much profit. Despite his findings, the Jensen alpha method failed to identify the difference that occurred in financial performance of social and conventional funds. It is rational to note that better performance of social funds is because of the large gap growth that exist and not because of social factors. Socially responsible mutual funds are significantly stronger supporters of corporate leadership shareholder resolution such as expensing stock options, vote no director campaign, declassifying boards and focusing on dangerous pills than are the conventional mutual funds that do not support these ideas (Vogel, 2006). Some business people usually believe that unethical or unscrupulous ways or means are sometimes significant for making gains in a portfolio. Thus, it is possible to make profit in portfolio while using ethical investment strategy. It is vital to look at how socially responsible investment and investors can apply socially responsible mutual funds to make this strategy practical. A socially responsible investing mechanism is the one that perceives successful investment returns and responsible business behavior as matching. Social responsible investment believes that by putting certain social strategy together with rigorous investment strategy, they can identify ways that will earn profits and help build a successful business. The conventional method to investment is not highly recommended by investment managers because of unevaluated risks in the market (Vogel, 2006). Socially responsible investment usually considers product safety and impact, workplace practices, human rights, community relations, corporate governance and ethics and finally indigenous people rights. Socially responsible mutual funds aim at promoting the adherence to ethical elements in this field, which house most companies. However, the socially responsible investment scrutinizes companies and industries that it views as bad in society in a manner in which they undervalue their customers and use unethical means to get profits at the expense of consumers. Socially responsible mutual funds hold securities in firms and companies that stick to moral, social, religious, and environmental believes. To make sure that chosen stocks contain values that concur with the funds beliefs, firms go through careful and serious screening process. A socially responsible mutual fund will grasp securities in firms that stick to high values and standards of good corporate relationship. In most cases, socially responsible mutual funds are recommended since they partition a part of their portfolio for locals or community investment. There is a general delusion is that these investments are donations to the community but this is not true since these investments allows investors to offer to the locals in need while making profit on their investment in the area (Vogel, 2006). The SRI funds model adopts few funds when practicing positive screens in their investment plans. funds entailing positive screens aim for involving firms that are known for their positive implementation of crucial decisions concerning sensitive issues such as environmental and community involvement confirmations. In addition, the other issue involved is the shareholder activism, which involves investors taking part in discussion, implementation, and selection of decisions of shareholders in a rational manner that is accepted by all participants. It is factual that the SRI funds use screens that limit potential diversification; it may transfer the mean variance frontier towards risks that are less favorable which shows return in tradeoffs than of their conventional counterpart’s portfolios. For example, excluding part of stock markets may negatively manipulate or influence the risk return tradeoffs of SRI funds. In this case, the SRI funds produce weaker investment opportunities for investors as some of these investments are excluded from the investment map since they do not contribute to the SRI goals of the funds. In addition, stricter and stiffer screening intensity reduces investment map or universe, which in turn may weaken performance of SRI funds. However, there are different theories that support the fact that SRI funds outperform the conventional funds. First, social, environmental, and ethical screening may lower or reduce the high costs that surface during corporate environmental disasters or social crises. Secondly, sound environmental and ethical performance shows high managerial standards and quality which translates into viable financial performance. In any case, if markets try to undervalue such costs, portfolios based on environmental, ethical, or social governance criteria will outperform their benchmarks (Schepers, 2009). In order for investors to bring down the risk of negatively manipulating certain investment, they opt for investment diversification. Investment diversification is achieved in the manner in which assortment of investment is carried out and by ensuring that they keep a broad of securities of firms. Investors of socially responsible mutual funds have a tendency of demonstrating higher degree of faithfulness towards their invested funds when it comes to low yields. They also demonstrate degree of sensitiveness when it comes to high profits (Renneboog et al 2008). Contrary to this, conventional investors are more concerned with the returns produced by the funds and any change in the returns is addressed with discontentment towards board of directors and the management. According to Renneboog et al (2008), socially responsible investment funds utilize positive and negative screens to identify and select companies for their portfolios. These screens take into consideration the social, environmental, and ethical criteria. The socially responsible mutual funds perform better than the conventional ones since the SRI funds include more careful and vibrant firms. However, SRI could perform badly if the screening method reduces the diversification potential, which occurs at a cost. The SRI approach should incorporate an asset pricing criteria that lures investment styles. For instance, the Fam-French-Carhart technique utilizes growth opportunities, share price, firm size, and the market to measure performance of investment funds. Research reveals that if the Fam-French-Carhart technique is used to compare the performance of SRI and conventional one, the SRI funds will not be in a position to outperform the conventional funds. The socially responsible mutual funds and their conventional counterpart perform almost in the same manner. However, research has shown that conventional mutual funds outperformed socially responsible mutual funds since investing in SRI meant that the investor had to forego few of proceeds about screening criteria of SRI funds model. The fund management and screening criteria are supposed to be investigated before making selection of fund. This would mean that few of prospective and revenue earning firms may be excluded based on screening specification. in this case, investors who are socially driven may demand for assortments that are consistent with their values and beliefs. The practice of screening criteria about investments has had increased expenses for the funds thus straining investors (Renneboog et al 2008). These additional expenses are then transferred to the customer of the fund, which in turn affect their net proceeds or returns. Conclusion Summarily, governance, ethical, social or environmental considerations influence stock markets and investors know what they want they use the SRI screening by funds. The main reason why investors prefer SRI funds investment criteria is based on aversion to corporate behavior, which is viewed as unethical or asocial by many people. Investors using the SRI funds model deviate from economically rational objective of wealth creation by pursuing social objectives. Research has revealed that SRI funds model underperforms in countries found in Asia-pacific, Europe, and Latin America because of domestic benchmark portfolio. In addition, the SRI returns underperform those of conventional funds if analyzed using the Fama-French-Carhart factors. References Schepers., D.(2009) Socially Responsible Investing. London: Routledge. Vogel., D. (2006). The Market for Virtue: The Potential and Limits of Corporate Social Responsibility. Washington, DC: Brookings Institution Press. Renneboog, L, Jenketer., H & Chendi., Z. (2008). The price of ethics and stakeholder Governance: The performance of socially responsible mutual funds. Journal of Corporate Finance 14:3, 302–322. Renneboog., L, Jenke ter H & Chendi., Z.(2008). Socially responsible investments: Institutional aspects, performance, and investor behavior. Journal of Banking and Finance 32:9, 1723–1742. Read More