The Opportunity Cost of Negative Screening in Socially Responsible Investing

Abstract

This paper investigates the impact of negative screening on the investment universe as well as on financial performance. We come up with a novel identification process and as such depart from mainstream socially responsible investing literature by concentrating on individual firms' conduct and by studying a much wider range of issues. Firstly, we study the size and financial performance of fourteen potentially controversial issues: abortion, adult entertainment, alcohol, animal testing, contraceptives, controversial weapons, fur, gambling, genetic engineering, meat, nuclear power, pork, (embryonic) stem cells, and tobacco. We investigate an international sample of more than 1,600 stocks for more than twenty years. We then analyze the impact of applying negative screens to a market portfolio. Our findings suggest that the choice for negative screening strategies does matter for the size of the investment universe as well as for risk-adjusted return performance. Investing in controversial stocks in many cases results in additional risk-adjusted returns, whereas excluding them may reduce financial performance. These findings suggest that there are opportunity costs to negative screening.

On the Price of Morals in Markets: An Empirical Study of the Swedish AP-Funds and the Norwegian Government Pension Fund

“…However, prior research indicates that performance effects may differ depending on the nature of the exclusionary screen (Barnett and Salomon 2006;Renneboog et al 2008b;Capelle-Blancard and Monjon 2014;Trinks and Scholtens 2015). Looking at the case of the GPFG and the AP-funds, we can differentiate between sector-based exclusions and norm-based exclusions.…”

“…Many studies have since attempted to confirm or disprove the original results by Hong and Kacperczyk (2009) and have extended the original set of screens to reflect a broader range of societal norms. For instance, studies by Adler and Kritzman (2008), Durand et al (2013a, b) and Trinks and Scholtens (2015) find support for an outperformance of sin stocks in the U.S. markets, Salaber (2013) for a European stock universe, Visaltanachoti et al (2009) for China and Hong Kong, and Fabozzi et al (2008) for a set of 21 global equity markets, respectively. However, there is also a considerable body of research that finds no or only an insignificant outperformance of sin stocks.…”

“…To illustrate, when categorising the above studies based on the type of exclusionary screens, we find that most studies cover sector-based exclusions (e.g. Adler and Kritzman 2008;Fabozzi et al 2008;Hong and Kacperczyk 2009;Trinks and Scholtens 2015;Salaber 2013;Humphrey and Tan 2014;Adamsson and Hoepner 2015), while currently three studies explicitly address norm-based screening (Blanc and Cozic 2012;Meller and Husson-Traore 2013;Capelle-Blancard and Monjon 2014). Thus, there is a clear need for further research on the performance impact of norm-based screening.…”

“…So far, the literature has either constructed theoretical portfolios by applying exclusionary criteria to a predefined investment universe (e.g. Adler and Kritzman 2008;Fabozzi et al 2008;Hong and Kacperczyk 2009;Durand et al 2013b;Salaber 2013;Trinks and Scholtens 2015) or it has analysed the performance of SRI mutual funds that apply exclusionary screening (e.g. Barnett and Salomon 2006;Renneboog et al 2008b;Lobe and Walkshäusl 2011;Humphrey and Lee 2011;Capelle-Blancard and Monjon 2014;Humphrey and Tan 2014).…”

Fossil Fuel Divestment Strategies: Financial and Carbon-Related Consequences

“…Finally, opportunity costs have been identified for SRI that exclusively applies exclusion as non-financial decision criteria (P. J. Trinks & Scholtens, 2015).…”