The Performance Implications of SR Investing: Past versus Future

Guenster Nadja

Abstract
This chapter discusses the impact of socially responsible investment (SRI) strategies on portfolio performance. It focuses on two common investment strategies: investing in firms with leading environmental, social, and governance (ESG) policies and shunning firms that are involved in "sinful" business activities. Examples of so-called sinful business activities are tobacco, alcohol, gambling, and weapons. Two opposite effects have influenced the performance of SRI methods over the last decades. First, a strategy of overweighting firms with high ESG standards and underweighting firms with poor standards earned positive abnormal returns. Second, SRI investors lost out on high returns on sin stocks. Although socially responsible investors, in aggregate, often experience similar performance to conventional investors, this is likely to change. In an efficient market, firms with high ESG standards should not earn higher returns than firms with low standards. The empirical evidence suggests that this equilibrium is approaching. Then, socially responsible investors missing out on the high sin stock returns are likely to underperform conventional investors.

Keywords
socially responsible investing (SRI); sin stocks; portfolio return; cost of capital