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Profitable Socially Responsible Investing? An Institutional Investor's Guide

Thursday, December 1, 2005



Author: Marc J. Lane, RFC

Reviewer: John E. Grable, Ph.D., RFC

The thought of socially responsible investing (SRI) usually conjures up images of financial left-wing activists or little old ladies heading off to a church social. The general impression is that SRI may serve the emotional side of one's life, but when it comes to making money, SRI is less effective than other forms of investing. The debate regarding the merits of SRI has raged for over twenty years. Finally, someone has entered the discussion with quantifiable evidence to suggest that SRI can be both altruistic and profitable. Marc Lane, who is a Registered Financial Consultant, has written a book based on his original research that deals with the advantages and disadvantages of SRI. Mr. Lane provides practical advice on how SRI can be adapted into a fiduciarily sound investment policy. This is a commendable achievement.

The book consists of 10 chapters separated into three sections. An outstanding SRI glossary is included, as is one of the most complete and authoritative reference lists currently available. The first section of the book provides a historical perspective on SRI. It is this section that Lane describes both the extent and definition of SRI. SRI has three components: (a) securities screening, (b) shareholder advocacy, and (c) community investing. The majority of readers will be most interested in Lane's perspective of SRI in securities screening and investment outcomes. Combined, approximately $2 trillion is invested in these three components.

According to Lane, SRI can be traced back to the 17th Century. It was during this time that the Quakers (Society of Friends) first introduced the concept of shunning certain industries involved in unethical activities (e.g., slave trade). Lane points out that SRI is widely applied in Judaism, Christianity, Islam, and other religions. One of the most refreshing aspects of this book is its broad review of SRI applications. Rather than focusing in on one religion or social issue, Lane provides examples of how SRI is used and applied throughout institutional settings. This is, in fact, the first book this reviewer has seen that references diverse religious perspectives in a non-condemning fashion. For example, examples of how SRI is used by the American Friends Service Committee, Unitarian Universalists, Christian Scientists, and other non-profit organizations are all discussed.

The second section of the book deals with how security screening (i.e., negative screening) impacts portfolio returns. Generally, proponents of SRI tend to screen out from portfolio investments associated with the tobacco, defense, alcohol, and gambling sectors of the economy. Sometimes stocks in these four industries are known as 'sin stocks.' Skeptics of SRI claim that excluding sin stocks reduces portfolio returns and increases portfolio risks. Interestingly, Lane concludes that this is true! He reports that:

"Excluding the four controversial industries caused the efficient frontier of portfolio combinations to shift to the right, thus demonstrating greater volatility (or risk) for each given level of expected return. The result is consistent with the general consensus that systematically excluding certain industries makes a portfolio less diverse and, consequently, riskier" (p. 49).

In simple terms, sin stocks tend to be less volatile than other stocks. This may be due to the inherent profitability of the industries in which they operate. Excluding sin stocks, then, tends to increase the systematic risk in a portfolio.

Does this mean that SRI, as a portfolio management tool, is dead? According to Lane, not at all. Lane concludes that negative screening (i.e., removing stocks from a portfolio) often leads to lower levels of diversification and increased risk. However, he asserts, with ample evidence to support hi argument, that 'positive screening' can be used to increase diversification, reduce risks, and increase returns. So what is positive screening? Positive screening is the process of selecting, rather than excluding, securities based on established SRI criteria. Specifically, positive screening looks for companies that provide social justice and environmental accountability. Lane lays out the argument for positive screening this way:

"For those seeeking to identify and promote higher standards of corporate conduct, a careful examination of management behavior may empower the investor, more effectively than negative screening by industry could ever have done, to deploy capital in a way that gives voice to the investor's principles and beliefs" (p. 51).

Positive screening, then, involves selecting securities for a portfolio based on behavioral social screening techniques. Lane defines behavioral screening as follows:

"'Behavioral social screening' is defined here as the social screening of portfolio based on three specific value-based corporate behavioral criteria involving company practices in the areas of (1) diversity and employee relations, (2) human rights, and (3) the environment. The areas of diversity and employee relations and human rights can be combined into a single category which will be referred to as 'social justice'" (p. 51).

Section two of the book concludes by quantitatively showing how using positive screening - seeking out companies that promote diversity, improved employee relations, human rights, and respect for the environment - tends to deliver superior absolute risk-adjusted returns compared tom portfolios developed using negative screens and portfolios created using modern portfolio techniques with no restrictions.

Skeptics of SRI may take Lane to task for showing few actual portfolios that match behavioral social screening techniques. Only a small number of specific companies are mentioned, and the narrative is limited to general descriptions of 'why' positive screening works in Chapters 6, 7, and 8. In general, one would hope for more specific guidance on what a behaviorally screened portfolio might look like. Given this constraint, however, Lane does provide readers with extensive detail on how one might go about actually positively screening a company. This is the focus of the book's third section.

Chapter 9 provides guidance on how negative and positive screens can be used. Examples of negative screens include excluding firms engaged in:

* Abortion
* Adult entertainment
* Alcoholic beverages
* Contraceptive devices
* Defense
* Firearms
* Gambling
* Nuclear power
* Tobacco

Behavioral (positive) screens include finding firms that show:

* Respect for the environment through -

* Pollution control
* Reduced environment hazards
* Recycling
* Alternative fuels
* Environmental disclosure
* Reduced toxic emissions

Diversity and emploee relations by -

* Employing disabled
* Gay and lesbian policies
* Affirmative action

Social justice through -

* Charitable giving
* Educational support
* Human rights

A perusal of the differences between negative and positive screens will undoubtedly cause controversy among advocates and skeptics of SRI. It appears that someone who employs behavioral social screens could, in fact, include securities of firms that operate in traditionally SRI excluded industries. This is a conflict that Lane does not address. For instance, ownership of a firm such as Disney may meet behavioral screens based on the firm's gay and lesbian benefits stance, charitable giving policy, and respect for the environment. However, these same firm specific actions may subject Disney to negative screens for investors that use SRI policies based on traditional Christian values. One is left wondering, after reading Lane's book, how an SRI investor - either individual or institution - should deal with these type of conflicting issues.

Overall, however, this book is one of the best written, most comprehensive, and well-documented treatises on SRI available today. Advocates of SRI will find Lane's analyses comforting as they develop portfolios based on positive social screens. Critics of SRI should also find the book worthwhile. It may be possible to use what is presented in the book as a catalyst for helping guide a new discussion about the boundaries surrounding SRI. If, for example, SRI is not constrained to negative screening of tobacco, alcohol, gambling, and defense stocks, then SRI may become more widely supported, especially if other studies can show a positive relationship between portfolio returns and positive screening techniques. Academicians would be well served to follow Lane's lead and study this important topic.

Purchase Information: Lane, M.J. (2005). Profitable Socially Responsible Investing? An Institutional Investor's Guide. London: Institutional Investor Books (an imprint of Euromoney Books). ISBN: 1-84374-136-9; the book may be purchased at for $95.00.


Author information: Marc J. Lane is President of Marc J. Lane Investment Management, Inc. He is a practicing Chicago attorney and financial advisor; an Adjunct Professor of Business at the University of Illinois; and the author of 32 books.





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