Tide is shifting everywhere to responsible investing strategies
• No SA evidence is found to support theories predicting outperformance of questionable shares
BlackRock, the largest asset manager in the world, says it will start redirecting investments away from fossil fuels. Some journalists described the decision as “seismic”, as vast amounts of money are likely to shift away from companies in dirty industries towards more sustainable ones.
As elsewhere, more investors in SA are embracing the aims and practicalities of responsible investing.
The oldest responsible investing strategy, and the one BlackRock is proposing, entails shunning companies that produce products and services that are harmful to society (such as alcohol, tobacco and gambling) and the natural environment (such as fossil fuels).
This strategy, which is called ethical or virtue investing, is often based on the investor’s moral or religious convictions.
A large and growing number of collective investment schemes in SA exclude companies based on Shari’ah screens. These screens filter out companies producing non-Halaal products (such as alcohol and pork), conventional banks and insurance companies.
Vice investing is diametrically opposed to virtue investing. Several international studies show that investors who are willing to invest in morally questionable shares, particularly those that involve addictive products and services, enjoy higher risk-adjusted returns than those who spurn these shares. Theories have emerged to explain the existence of this observed vice risk premium.
One suggests that morally questionable shares are likely to produce superior returns due to their addictive nature. Another, the neglected stock theory, says that due to being shunned by institutional investors, vice shares are systematically underpriced. It has also been suggested that the high barriers to entry in most of the “sin” industries, and the corresponding high margins, contribute to abnormal returns.
Investors who are contemplating a more ethical or responsible investment approach might thus be rightfully concerned about the opportunity costs of shunning vice shares.
It is against this backdrop that we compared the risk-adjusted performance of a portfolio of morally questionable shares listed on the JSE with a portfolio consisting of morally acceptable (responsible) ones.
We defined morally questionable companies as those that produced alcohol and tobacco, generated a substantial percentage of revenue from gambling, and those involved in the oil, gas and coal sectors. This definition captured harm done to society and/or nature.
In line with previous researchers, we regarded morally acceptable companies as those that were constituents of the FTSE/JSE responsible investing index over the period 2004 to 2019. However, we excluded mining shares and other morally questionable companies (as defined earlier).
This index and its predecessor, the JSE SRI index, scores JSE-listed companies on a range of environmental, social and corporate governance ) considerations. Constituents have policies and practices in place to reduce their environmental impact, promote socio-economic development and adhere to the principles of fairness, accountability, responsibility and transparency. The relative cost saving resulting from not being exposed to litigation, environmental restitution risks or carbon taxes can contribute to higher expected future cash flows and company value.
The historic, risk-adjusted returns of the two portfolios (morally questionable and morally acceptable) were compared to the FTSE/JSE responsible investing index, the FTSE/JSE shareholder weighted index (Swix), and an equally weighted benchmark. No evidence was found to support the theories predicting the outperformance of morally questionable shares listed on the JSE.
The morally acceptable portfolio generated the highest absolute arithmetic monthly mean (1.59%), geometric monthly mean (1.50%) and compounded annual return (19.53%) of all the considered portfolios. This portfolio recorded the highest maximum monthly return, suggesting morally acceptable shares can produce outperformance on an absolute return basis.
The empirical evidence confirms previous responsible investing studies in SA, which reported the underperformance of the FTSE/JSE responsible investing index compared to the FTSE/JSE all share index. By using a narrower definition of morally acceptable investing, we found that the non-financial benefits of RI do not come at an additional financial cost.
The morally questionable portfolio had similar riskadjusted results to the equally weighted benchmark. This observation could suggest that there is no morally questionable risk premium available on the JSE. Investors who are not constrained by responsible investing mandates will thus not be better off by following a morally questionable strategy.
Our study shows that socially and environmentally conscious investors on the JSE achieved risk-adjusted returns comparable to morally questionable shares and conventional benchmarks over the sample period.
These investors do not need to tolerate lower financial returns to derive the nonfinancial utility associated with responsible investing. We conclude it is not better for investors to be bad, but to allocate their capital to JSE-listed companies that take decisive steps to improve their social and corporate governance policies and practices.
Investors of all sizes should reflect on BlackRock’s announcement and responsible investing strategies that could reshape the relationship between money and the climate crisis.
A LARGE NUMBER OF INVESTMENT SCHEMES IN SA EXCLUDE COMPANIES BASED ON SHARI’AH SCREENS
INVESTORS OF ALLSIZES SHOULD REFLECT ON BLACKROCK ’ S ANNOUNCEMENT