Why Do Investors Hold Socially Responsible Mutual Funds?

• DOI: http://doi.org/10.1111/jofi.12547
• Date: 01 December 2017
• Published date: 01 December 2017

THE JOURNAL OF FINANCE •VOL. LXXII, NO. 6 •DECEMBER 2017

Why Do Investors Hold Socially Responsible

Mutual Funds?

ARNO RIEDL and PAUL SMEETS∗

ABSTRACT

To understand why investors hold socially responsible mutual funds, we link ad-

ministrative data to survey responses and behavior in incentivized experiments. We

find that both social preferences and social signaling explain socially responsible in-

vestment (SRI) decisions. Financial motives play less of a role. Socially responsible

investors in our sample expect to earn lower returns on SRI funds than on con-

ventional funds and pay higher management fees. This suggests that investors are

willing to forgo financial performance in order to invest in accordance with their social

preferences.

SOCIALLY RESPONSIBLE INVESTMENTS (SRIs) are increasing in economic and fi-

nancial importance, as testified by their growing volume in Europe and the

United States (EUROSIF (2014), Social Investment Forum (SIF, 2014)). In

the United States, for instance, already one in nine dollars of professionally

managed assets are involved in SRI. These investments are a puzzle in fi-

nance, however, because they deviate from the market by excluding potentially

high-return “sin” companies from their portfolio or by focusing on companies

∗Arno Riedl is with CESifo, IZA, Netspar, and the Department of Economics (AE1), School of

Business and Economics, Maastricht University. Paul Smeets is with the Department of Finance

and European Centre for Corporate Engagement (ECCE), School of Business and Economics, Maas-

tricht University. A former version of this paper was previously circulated under the title “Social

Preferences and Portfolio Choice.” We are grateful to Robeco for providing us with the administra-

tive data used in this paper and we particularly thank Peter Jurriaans, Catrien Kleinheerenbrink,

Manon Middelink, and Jorg Sunderman. This paper benefited especially from the comments and

suggestions of two anonymous referees, an anonymous Associate Editor, and the Editor (Kenneth

J. Singleton), as well as of Clifton Green, Chris Parsons, and Nicolas Salamanca. We are also grate-

ful to the valuable comments of Rob Bauer, John Beshears, Thomas Dohmen, Piet Eichholtz, Uri

Gneezy, Arvid Hoffmann, Christine Kaufmann, Stephan Meier, Thomas Post, Sebastien Pouget,

Walid Saffar, Tao Shu, Avi Wohl, and Leonard Wolk. We thank seminar and conference partici-

pants at the EFA 2013, Society for Experimental Finance 2014 conference, Science of Philanthropy

Initiative 2015, ToulouseSchool of Economics, UC San Diego Rady School of Management, UC San

Diego Applied Microeconomics, and University of Heidelberg. We also thank Philip Abele, Oana

Floroiu, John Kramer, Mohammedreza Maghroor, Tobias Ruof, Simone Vermeend, and Thorsten

Voss for their help as research assistants. Paul Smeets received financial support from MISTRA

and the European Centre for Corporate Engagement (ECCE). Part of this paper was written while

Paul Smeets was visiting the Rady School of Management (UC San Diego). Paul Smeets is sup-

ported by a VENI grant from the Netherlands Organisation for Scientific Research (NWO) under

grant number 016.Veni.175.019. The authors declare no conflict of interest.

DOI: 10.1111/jofi.12547

2505

2506 The Journal of Finance R

that have high scores with respect to environment, human rights, employee

relations, and so forth (SIF (2014)).

Why do investors hold socially responsible mutual funds? While it is tempting

to conclude that strong prosocial preferences drive this decision, other motives

are also possible. On the financial side, investors may have optimistic risk-

return expectations for SRI or a desire to diversify their portfolio risk. Another

possible motive could be that investors hold SRI to boost their social image or

reputation.

The theoretical and empirical evidence regarding these possible explana-

tions is inconclusive. With respect to social preferences, some theoretical mod-

els assume that investors may be willing to pay a premium to invest in so-

cially responsible companies (e.g., Heinkel, Kraus, and Zechner (2001), Gollier

and Pouget (2014)). Other recent theoretical contributions imply that holdings

of SRI funds do not necessarily reflect social preferences (Dufwenberg et al.

(2011), Sobel (2015)). Direct empirical evidence on the role of social preferences

in SRI is missing.

A few empirical studies show that SRI equity may perform financially better

(or not worse) than conventional investments.1Other studies, however, find

that investing in a socially responsible manner is financially costly.2Thus, it is

impossible to deduce from prior literature whether investors hold SRI equity

funds because they expect these funds to outperform conventional equity funds;

there exists little direct empirical evidence on whether investors expect SRI

funds to perform better than conventional funds (Nilsson (2008), Bauer and

Smeets (2015)).

Regarding reputation motives, several theoretical and experimental papers

emphasize the importance of creating a positive social image via social signal-

ing.3Investors could achieve such a positive image, for instance, by talking to

others about their SRI. As far as we know, however, no study explores social

reputation as a possible motive for SRI.

In this paper, we shed light on why investors hold socially responsible mu-

tual funds by combining administrative investor data, behavior in incentivized

experiments, and survey data. Specifically, we first obtain administrative data

from a large mutual fund provider that offers a wide variety of socially respon-

sible and conventional mutual funds. Individual investors buy and sell their

funds directly online without the interference of an intermediary. We then

1See, for instance, Bauer, Koedijk, and Otten (2005), Derwall et al. (2005), Kempf and Osthoff

(2007), and Edmans (2011). Moreover, Karpoff, Lott, and Wehrly (2005) find that the losses of

firms that violate environmental regulations are equal to the legislation costs but that firms face

no additional costs due to reputation loss.

2For instance, Fabozzi, Ma, and Oliphant (2008) and Hong and Kacperczyk (2009) find that

divesting from sin industries that involve weapons, tobacco, alcohol, or gambling is costly because

these companies tend to perform better than “nonsin” companies. Moreover, Kr¨

uger (2015)finds

that stock prices sometimes react negatively to positive corporate social responsibility (CSR) news.

3Theoretical contributions include Glazer and Konrad (1996), B´

enabou and Tirole (2006), and

Ellingsen and Johannesson (2008). Empirical evidence is provided by Ariely, Bracha, and Meier

(2009), Fehrler and Przepiorka (2013), and Cappelen et al. (2017).

Why Do Investors Hold Socially Responsible Mutual Funds? 2507

merge these data with results from a survey and incentivized experiments

that we conducted using a large group of individual investors. We thus create

a unique data set that links the administrative data of conventional and so-

cially responsible investors to their behavior in controlled experiments and to

answers in a comprehensive survey.

To investigate the potential effects of social preferences on portfolio choice,

it is necessary to have a clean and independent measure of such preferences.

This measure should ideally be unaffected by strategic reputation considera-

tions (Kreps et al. (1982)) or social image concerns (Ellingsen and Johannesson

(2008)). To obtain such a measure, we let investors participate in a controlled

and anonymous one-shot trust game experiment (Berg, Dickhaut, and McCabe

(1995)). The trust game is a two-player sequential move game where the first

mover can transfer money to the second mover. The transferred amount is

tripled by the experimenter. The second mover can send back to the first mover

all, parts, or none of the money received. The behavior of the first mover mainly

captures trust, which is why the game is called a trust game. However, we want

to capture social preferences rather than trust. We therefore use the behavior

of investors in the role of second movers to measure intrinsic social preferences

(Karlan (2005), Falk, Meier, and Zehnder (2013)). A second mover who behaves

like the prototypical homo economicus should not send back any money. The

more an investor in the role of second mover returns, the stronger are the

investor’s intrinsic social preferences.

We find that intrinsic social preferences play an important role in deter-

mining SRI. An investor who equally shares the money in the experiment is

14 percentage points more likely to hold an SRI equity fund compared to a self-

ish investor who keeps all the money. This effect is economically substantial as

only 16% of our total sample holds an SRI equity fund. We also find that social

signaling motivates investors’ SRI equity holdings; investors who talk more

often about their investments are more likely to invest in a socially responsible

way.Moreover, socially responsible investors donate about 41% more to charity

than conventional investors, implying that SRI is not a substitute for charity

donations.

Financial motives also play a role in whether investors hold SRI. On the one

hand, we find that investors are willing to pay significantly higher management

fees on SRI funds than on conventional funds and a majority of investors expect

SRI funds to underperform relative to conventional funds. On the other hand,

we find that investors who expect SRI equity funds to underperform relative

to conventional equity funds are less likely to invest in a socially responsible

manner. Hence, our evidence indicates that some investors are willing to forgo

financial performance in order to invest in mutual funds that are in concor-

dance with their social preferences, but at the margin pessimistic performance

expectations reduce the likelihood of investing in a socially responsible way.

Investors who expect SRI equity funds to perform financially better than con-

ventional equity funds are not more likely to hold such funds.

Risk perceptions are unrelated to holdings of SRI funds. However, investors

who generally hold funds longer are more likely to invest in SRI equity funds,