Theory and empirical evidence on socially responsible investing and investment performance: Implications for fund trustees and their members

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Guidance is required for investors and trustees as to the potential impact of socially responsible investing on expected returns and risk. This paper examines the theoretical and empirical evidence with respect to this impact.

The evidence suggests that very well governed companies with strong employee relations and strong environmental performance may earn positive abnormal returns. However, for poorly governed companies socially responsible investing may involve agency costs that result in underperformance. Further, investing in firms whose core business is in industries that are widely seen as “sin” industries may earn positive abnormal returns, and avoiding these firms may impose a financial cost on investors. Nevertheless, for investors with a diversified portfolio, the overall financial effect of socially responsible investing may be marginal.

In those cases where socially responsible investing may be expected to result in financial harm to fund members, trustees may be in breach of their fiduciary duties. One possible reform that may be considered is to allow trustees to consider non-financial criteria without breaching their fiduciary duties, provided that other prudential requirements are met.

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This paper was produced under the ACFS Commission Research program, which supports academics to conduct practitioner-oriented research. Further details about the program and other ACFS research grants, are available here.