IMPORTANCE OF THE FUND MANAGEMENT COMPANY IN THE PERFORMANCE OF SOCIALLY RESPONSIBLE MUTUAL FUNDS

• DOI: http://doi.org/10.1111/jfir.12127
• Author: Ephraim Clark,Yacine Belghitar,Nitin Deshmukh
• Date: 01 September 2017
• Published date: 01 September 2017

IMPORTANCE OF THE FUND MANAGEMENT COMPANY IN THE

PERFORMANCE OF SOCIALLY RESPONSIBLE MUTUAL FUNDS

Yacine Belghitar

Cranfield University

Ephraim Clark and Nitin Deshmukh

Middlesex University

Abstract

We compare the performance of a sample of U.K.-based socially responsible investment

(SRI) funds with similar conventional funds using a matched-pair analysis based on size,

age, investment universe, and fund management company (FMC). We find that both the

SRI and conventional funds outperform the market index about 50% of the time, even

after fees. Subsample tests show that the SRI funds in our sample perform better in the

pre- and postfinancial crisis periods but underperform during the financial crisis period.

Importantly, we find that the FMC plays a major role in the outperformance of both SRI

and conventional funds.

JEL Classification: G1, G11

I. Introduction

Socially responsible investment (SRI) funds, whereby managers filter their investments

based on environmental, social, and governance criteria, originated as a niche

complement to conventional portfolio diversification. Since then it has grown by leaps

and bounds to become a mainstream strategy in its own right. For example, as of 2015,

SRI accounted for 11% ($3.74 trillion out of $33.7 trillion) of assets under management

in the United States

1

and 27% (£1.235 trillion

2

out of £4.5 trillion

3

) of assets under

management in the United Kingdom. The sheer size of the SRI market and the increasing

attention that a growing number of retail and institutional investors are devoting to the

theme makes it important to understand the extent to which SRI affects investment

performance. This study looks at a sample of U.K.-based SRI funds and compares their

performance with general market indices as well as with similar conventional funds that

We are grateful to Mark Griffiths (associate editor) for his valuable comments that have significantly

improved the paper’s quality and contribution. We also thank Scott Hein, Jeff Mercer, and Drew Winters (editors)

for guiding us through the entire process. All errors and omissions are our own.

1

The Forum for Sustainable and Responsible Investment (http://www.ussif.org/sribasics).

2

UK Sustainable Investment and Finance Association (http://uksif.org/about-uksif/history/).

3

Investment Management Association (http://www.investmentuk.org/research/ima-annual-industry-survey/

key-statistics/).

The Journal of Financial Research Vol. XL, No. 3 Pages 349–367 Fall 2017

349

© 2017 The Authors. The Journal of Financial Research published by Wiley Periodicals, Inc. on behalf of The Southern Finance Association and

the Southwestern Finance Association

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs License, which permits use and

distribution in any medium, provided the original work is properly cited, the use is non-commercial and no modifications or adaptations are made.

RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN

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have been carefully matched with respect to a set of criteria designed to isolate the effect

of the socially responsible aspect of the investment.

Theory suggests that because SRI fund managers face a smaller or more

restricted investment universe than conventional fund managers, the latter should be able

to outperform the former. Studies of whether SRI mutual funds outperform or

underperform relative to conventional funds provide inconclusive results. Numerous

studies that find no conclusive evidence of over- or underperformance simply ignore the

effect that factors such as fund size, age, investment universe, and so on, could have on

fund performance. For example, Hamilton, Jo, and Statman (1993) compare the

performance of U.S. SRI funds with randomly selected conventional funds. Luther and

Matatko (1994) compare the performance of U.K. SRI funds with the FTSE All Share

Index. Bauer, Koedijk, and Otten (2005) compare U.S., U.K., and German SRI funds

with a large number of conventional funds (both dead and alive) in each country. Other

studies, such as Mallin, Saadouni, and Briston (1995), Gregory, Matatko, and Luther

(1997), and Kreander et al. (2005), use a matched-pair approach, whereby they first

match the SRI funds with similar conventional funds based on size, age, investment

universe, and country and then compare their performance. None of these studies

consider the effect that the fund management company (FMC) could have on

performance. Elton, Gruber, and Green (2007), however, show that fund returns are

closely correlated within fund families. The FMC influences investment practices, access

to research, the institutional framework, and the ability to attract and retain talented fund

managers based not only on remuneration but also on the work culture and intellectual

freedom offered to the managers within the organization. Thus, differences in

performance between SRI and conventional funds could be due to the company

managing the fund and not the nature of their investment universe.

In this article we investigate the role that the FMC plays in the relative

performance of SRI versus conventional funds. We proceed in two steps. In step 1, to

neutralize the effect of the FMC on fund performance, in the matching exercise we

include the FMC as a selection criterion along with size, age, investment universe, and

country. In step 2, we test whether the FMC is a significant determinant of the

performance results obtained in step 1.

One salient characteristic of the SRI literature is the use of risk-adjusted returns

to measure fund performance in asset pricing models such as the capital asset pricing

model (Sharpe 1966; Lintner 1965), the Fama–French (1993) three-factor model, the

Carhart (1997) four-factor model, and so on, to calculate excess returns reflected in alpha,

which is then compared across SRI and conventional funds as well as the benchmark

market index. The shortcomings of these models are well known. They introduce their

own set of assumptions into the analysis, such as model specification and the normality of

returns. They also neglect the higher moments beyond the mean and variance of return

distributions. Since Mandelbrot (1963) raised the issue, it has been well documented that

asset returns are generally not normally distributed. Furthermore, it has been shown that

the third and the fourth moments of return distributions—skewness and kurtosis,

respectively—do matter to investors, who show a preference for positive skewness and

an aversion to kurtosis (see Kraus and Litzenberger 1976; Fang and Lai 1997; Dittmar

2002; Post, Levy, and Vlient 2008). Importantly, Clark and Kassimatis (2013) show that

350 The Journal of Financial Research