Elsevier

Journal of Banking & Finance

Volume 77, April 2017, Pages 53-63
Journal of Banking & Finance

Does corporate social responsibility affect mutual fund performance and flows?

https://doi.org/10.1016/j.jbankfin.2016.10.009Get rights and content

Abstract

We use an asset-weighted composite corporate social responsibility (CSR) fund score to study the effects of CSR on fund performance and flows. Compared to low-CSR funds, high-CSR funds display poorer performance, stronger performance persistence, a weaker performance-flow relationship, and comparable persistence in flows. These findings are consistent with investors in high-CSR funds deriving utility from non-performance attributes.

Introduction

Whether corporate social responsibility (CSR) enhances or reduces mutual fund performance is an important, long-standing question in the mutual fund literature.1 The intensity of this debate has further increased in light of the tremendous growth in socially responsible investment (SRI) funds. According to the Social Investment Forum (SIF), U.S. SRI assets under fund management registered an increase from $12 billion in 1995 to $1,013 billion in 2012, and an increase in their relative market share from less than 1% to nearly 8% over the same period.2 Despite this striking growth, the literature has reported no exceptional return performance for U.S. SRI funds.

To examine the impact of CSR on fund performance, the mutual fund literature has adopted a dichotomous approach by comparing a group of funds that fully conform to ethical standards (i.e., SRI funds) to the remaining funds that are called “conventional funds”. However, in comparing SRI to conventional funds, the literature compares two samples with unequal sizes and dissimilar characteristics. It also ignores heterogeneity in the intensity of social screening among SRI funds (e.g., Barnett and Salomon, 2006). To overcome these issues, the current paper suggests a simple holdings-based measure to assess the level of a fund's CSR. The measure is a value-weighted score using firm-level CSR ratings of portfolio holdings. With this measure, we are able to examine the impact of CSR on fund performance on a continuum basis, without resorting to the dichotomous categorization into SRI and conventional funds. Consequently, we are able to compare funds, based on the CSR criterion, cross-sectionally and across time. This measure could be used as an additional criterion by mutual fund investors.

In examining the relationship between CSR and fund performance, two hypotheses compete. On the one hand, investing in firms that implement CSR practices is likely to reduce the set of investment opportunities (Geczy et al., 2005, Renneboog et al., 2008b, Cortez et al., 2009) and increase monitoring costs (Bauer et al., 2005). CSR would then negatively impact fund performance. On the other hand, fund managers that target socially responsible firms may in fact be selecting firms with strong financial fundamentals, which in turn would translate into higher fund performance. In this case, investing in socially responsible stocks would be a value-generating strategy.

Empirically, the literature has reported mixed evidence as to the existence of a significant difference in performance between SRI and conventional funds in U.S. markets. For instance, Bauer et al. (2007) find that ethical funds significantly underperform conventional funds, while Gil-Bazo et al. (2010) report the opposite finding. Nofsinger and Varma (2014) find that SRI funds outperform their conventional peers during times of crisis, and underperform at other times. However, most of the studies on U.S. mutual funds find no statistical difference in the performance between SRI and conventional funds (e.g., Hamilton et al., 1993, Goldreyer and Diltz, 1999, Statman, 2000, Schröder, 2004, Geczy et al., 2005; and Renneboog et al., 2008b). We contribute to this debate on the impact of CSR on fund performance. However, instead of comparing SRI to conventional funds in a dichotomous way, we introduce a finer fund-level analysis using portfolio holdings, as defended by Borgers et al. (2015). We are thus able to shed light on the potential interaction between CSR and fund performance, without resorting to potentially biased matching procedures and conflicting SRI screening processes.

Using a sample of 2,168 U.S. equity funds over the period of 2003 to 2011, we examine the impact of CSR on the following fund-related characteristics: (i) performance, (ii) performance persistence, (iii) flow-performance relationship, and (iv) flow persistence. First, we provide evidence that an increase in the level of CSR comes at the expense of a reduction in performance. Indeed, our empirical results reveal that the CSR score of the portfolio is negatively related to risk-adjusted performance. This result holds even when we control for fund characteristics (such as volatility, flows, size of the assets under management, number of stocks, expense ratio, and turnover) and employ alternative definitions of the CSR score. Furthermore, we find that the CSR score negatively predicts future fund performance. When considering CSR strengths and concerns separately, we find that performance is more sensitive to strengths than to concerns. These findings complement those of Borgers et al. (2015), who show that funds with higher exposure to sin stocks display higher risk-adjusted performance. Second, we examine the performance persistence of funds. For the entire sample, we find a negative one-year-lagged performance coefficient, attesting to the presence of performance reversal. More importantly, our findings reveal that performance reversal decreases as fund CSR increases.

Third, we examine the flow-performance relationship. Prior work in the mutual fund literature has shown that investor flows respond positively and significantly to past performance (e.g., Chevalier and Ellison, 1997, Sirri and Tufano, 1998). Our empirical tests confirm the positive flow-performance relationship for the entire sample. Moreover, we find that this relationship weakens as fund CSR increases. Therefore, we confirm that investors in more socially responsible funds become less responsive to past performance, and derive their utility from non-financial attributes. These findings hold when we split the sample into retail and institutional investors; when we use the top 10 holdings in computing the CSR score; or when we sort funds into high and low-performing groups. These results are in line with Benson and Humphrey (2008) and Renneboog et al. (2011), who find that SRI fund flows are less sensitive to past performance than those of their conventional counterparts.

Finally, we examine the persistence of fund flows. Anecdotal evidence suggests that socially conscious investors may find fewer suitable investment opportunities relative to performance-chasing investors. Therefore, socially conscious investors may be less likely to switch from one fund to another. However, inconsistent with this conjecture, our results show that flow persistence does not relate to fund CSR.

The remainder of the paper is organized as follows. In Section 2, we review the literature on the performance and flows of SRI and conventional funds. In Section 3, we describe the sample selection and the variables used in the study. In Section 4, we study the relationship between the fund CSR score and fund characteristics. In Section 5, we examine the effects of fund CSR on fund performance and flows. We conclude in Section 6.

Section snippets

Performance of SRI funds and conventional funds

Two conflicting arguments have been proposed in the mutual fund literature to explain the relationship between performance and social responsibility. On the one hand, investing in SRI funds might be costly because the set of investment opportunities is smaller for this category of funds. On the other hand, funds using an SRI screening process may in fact target firms with a more sustainable profitability and better long-term prospects. Thus, the first argument aligns with SRI funds

Sample selection

We use the Center for Research in Security Prices (CRSP) Mutual Fund Database and the MSCI ESG KLD STATS (henceforth KLD) database to construct a sample of mutual fund CSR scores. The CRSP provides mutual fund characteristics such as expense ratios, turnover ratios, total net assets, returns, and holdings. These fund characteristics are aggregated at the portfolio level using asset-weighted averages of share classes. We rely on the Lipper-style classifications to select only actively managed

Fund CSR score and fund characteristics: univariate analysis

We sort funds each year into two groups based on whether they have high (i.e., above-median) or low (i.e., below-median) CSR scores. Then, we compute the average fund characteristics for the high and low-CSR funds, and estimate the differences between the two groups. Table 2 reports the univariate results. The difference in performance between the high and low-CSR funds is negative when considering both raw returns and alphas, although it is significant for only the latter. That is, a high CSR

Does CSR predict fund performance?

Renneboog et al. (2008b) posit that socially responsible funds invest within a smaller universe of stocks, and this is likely to harm the performance of this category of funds. However, the multiple screening steps taken by socially responsible funds’ managers may well eliminate poorly managed companies with underperforming stocks. The latter argument aligns with higher performance of socially responsible funds. Here, we test these arguments in our sample of funds to verify whether a high CSR

Concluding comments

This paper examines the effects of CSR on fund performance and flows. To gauge such effects, extant research has thus far relied on a comparison between SRI and conventional funds. While this approach has the advantage of comparing two distinct fund categories, it comes at the cost of ignoring the amount of heterogeneity within each one. Moreover, the fund categorization itself is still subject to debate, as various screening processes exist and may sometimes provide conflicting fund

Acknowledgments

We would like to thank for helpful comments: Geert Bekaert (Editor), Lawrence Kryzanoswki, Eli Sherrill, Meir Statman, an anonymous referee, and participants at the Midwest Finance Association meeting (2016).

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