Mutual Investment Funds


Introduction

In the course of the last ten years, there has been a steady rise in the number of ethical investment mutual funds also known as social investment mutual funds. The trend of social investment is very old as it started many civilizations ago. However, the modern form has been as a result of economic hardships, which started in the 60s. There were many issues that were present in the political climate during this period that ranged from nuclear energy, the environment, and the civil rights movements. This led to investors’ social awareness; thus, the concept was to make sure that any form of investment followed ethical criteria. This led to the creation of ethically managed investment funds that have been steadily increasing and represent a large amount of money invested in a country like the United States. About 12% of funds that are being professionally managed are part of a socially responsible mutual fund or of other private portfolios.

The fact that there is a very large amount of money invested in this manner has led researchers to attempt to answer the question whether these ethical investment mutual funds are more expensive to run and perform better than the other conventional investment mutual funds. Initial research shows that the ethical investment mutual funds do not invest as widely as the conventional ones. However, there is no major difference between the amounts of money earned by the ethical investment mutual funds when compared to the conventional ones (Diltz, 1995). Statistics also showed that there is no difference in the areas that the two types of investment mutual funds tend to invest in (Sauer, 1997). Most of the evidence necessary to make the important comparisons between the two types of investment mutual funds is mostly found in the United States and the United Kingdom. Additionally, there is no pattern of investment that can conclusively determine the differences between the two types of investment mutual funds. However, when the ethical investment mutual funds are compared according to investment in small companies with the other non-ethical ones, a bias is found (Luther & Matatko, 1994). It showed that the ethical funds were the better performing and earned more than the conventional ones in these small companies.

A different study that was conducted by Mallin et al. (1995) attempted to erase the problem of the benchmark that was set on the small companies and the investment by the ethical investment mutual funds. In this study, they considered the size of the ethical fund and the date that it was created. A method of statistics referred to as the Jensen’s alpha was used to analyze their findings. They concluded that ethical funds outperform the other funds using this criterion. The small cap bias that was cited by Luther and Matatko (1994) and that Mallin et al. (1995) attempted to correct led to further research by Luther and Matatko which concluded that using the size of the fund and applying the 2-factor Jensen’s alpha method; there was no conclusive evidence that reflected a difference in the financial performance of both investment mutual funds and that the small cap bias still existed.

The study of the differences between the two types of investment mutual funds was complicated at this point. It was further complicated when Dibartolomeo (1996) and Kurtz (1997) claimed that the better performance of the ethical investment mutual funds was due to “large-cap growth exposures” and not due to the social factors essentially considered. This presented further biases attributed to sector and style.

The purpose of this paper is to examine subsequent research in order to uncover the differences between the ethical investment mutual funds and the conventional investment mutual funds in order to determine whether the former performs better than the latter. This paper will not aim to discredit any research conducted, nor will it seek to be investigative but it will simply seek to document what other researchers have already done on the topic and draw conclusions from their researches.

Discussion

Ethical investment mutual funds usually invest in companies that are socially responsible. The trend in the current market economies is based on a socially acceptable or ethical investment portfolio. Therefore, those companies that are more considerate of the environment and those viewed as being free of accounting fraud are the likeliest investment alleys for the ethical investment mutual funds. The conventional investment mutual funds do not have such considerations. They will invest in any company that present a chance to increase profit margins. The trend of investing in companies that are deemed more ethical may mean that some companies will present themselves as being unfit for investment and may find themselves short on investors. This trend is therefore expected to lead to a more ethical corporate environment. The downside of having ethical constraints for companies is that the inferior investment portfolios may be affected since they may not have the influence in equity. Those that predict that this downside will cost the performance of the inferior portfolios to be affected cite the fact that the ethical investment is part of larger security investments and thus may prevent growth and diversification due to the constraints. Similarly, they cite that the construction of ethical screens aimed at gauging the extent of social responsibility of a company is itself a costly affair and thus may be a catalyst in the reduction of returns realized from the investments. Furthermore, they cite that during recession and other hard economic times, it is more lucrative not to be ethical.

The above reasons that have been forwarded by some theorist and tend to insinuate that the conventional investment mutual funds are better positioned to be more profitable as they do not have the moral burden weighing on their shoulders. From this logical discussion alone, it is possible to conclude that the ethical investment mutual funds do not have as much a chance of being successful as do the other types of conventional mutual funds. However, research that is aimed at crediting these views has not been forthcoming. In fact, as preliminary findings have indicated, there is no difference between the performances of both types of investment funds.

However, the traditional research conducted largely depended on the Sharpe or the Jensen’s alpha measure using a standard index to attempt to draw comparisons between the ethical and conventional investment mutual funds. The data produced in these studies was also largely drawn from the United States, the United Kingdom, and Australia. Despite the impression that the data from these studies may indicate the evidence from these regions is largely same-specific. As the data presented from these nations was not conclusive, it is prudent to examine the researches that have been done in other countries. There have been studies conducted in Canada. Although the country is the second largest retail market in the world, there has been limited data arising from its mutual funds investment market.

Initial research that was done in the country using the domestic equity and the TSE 300 index and the performance recorded that there was no difference found that gave any statistical evidence between the ethical investment mutual funds and the conventional investment mutual funds (Asmundson & Foerster, 2001). The only conclusion that this study made was that ethical investment appeared less risky than the conventional investment. The study did not however directly compare the ethical investment mutual funds with the conventional investment mutual funds wholly but rather assumed a sort of compromise conventional mutual fund, averagely presented.

As with all the other researches in the US and the UK, some benchmarks were considered in Canada that were aimed at removing any biases that occurred. Additionally, with advance in statistical approaches the Jensen alpha method was not applied here but a more complex multi-dimensional approach developed by Fama and French (1993) which incorporated “a value weighted market proxy, a factor capturing the risk premium associated with small versus large company stocks and a variable that accounts for the value versus growth stock premium”. The use of a multifactor approach assists in explaining the performance of ethical investment mutual funds (Bauer et al., 2005). Additionally, the performance of ethical funds investment can be analyzed in detail using these multifactor models. As a control, Bauer et al. (2007) used a single factor model. The single factor approach did not yield any significant difference in performance between the ethical investment mutual funds and the conventional investment mutual funds. Additionally, they found that using the single factor approach and a standard market proxy, more explanations were gotten than in using an ethical equity index. This result surprised them as “it cast doubt on the distinctive ethical component of ethical investment mutual funds”. The third conclusion from this research was gotten using the multi factor approach which considered book-to-market, size of the mutual fund and the momentum of the stock price. The conclusion just like with the single factor approach was that there was no significant difference between the ethical investment mutual funds performance with that of the conventional investment mutual funds. Further, there was no evidence that the style of ethical fund investment differed in any way from that of the conventional funds.

Researchers that advocate for corporate social responsibility argue that it is going to be more economically rewarding in the future. However, the reason they give for this is that the trend of corporate social responsibility (CSR) will reflect a higher quality management level and may present an advantage from comparison with those that are less socially responsible. As we have looked at research that is conducted in the US, the UK and in Canada, which are arguably the most developed markets for social investment mutual funds without any conclusive statistical evidence between the two types of investment mutual funds, it is prudent to examine other parts of the globe in an attempt to better understand the differences between the two types of investment mutual funds. There are three studies that have been conducted in other European countries and these are going to form the basis for the next part of the discussion. All other researches have applied differing methods of statistical analysis. These studies have used a conditional model whose main focus is on time. However, there are some variations as either the time-varying risks or the time-varying estimates are used depending on the economic conditions. In some cases, both are used. This conditional model was developed by Christopherson et al. (1998). One assumption is that the ethical investment mutual funds criteria will fit in with the conventional investment mutual funds criteria but the reverse is not true. That assumption is preemptive as it is meant to reassure investors that although they may choose to invest in the social investment mutual funds, they will not be sacrificing any financial gains.

There have been arguments that companies that are more socially responsible have a better financial performance record than those that do not. It is however very difficult to measure social performance of any company and this makes that argument unproven. Research is more focused on the argument that the investment in social investment mutual funds causes many investors to forego diversification versus the claim that social responsibility forces companies to undergo an ethical screen, which determines which companies present the best platform for investment. Nearly all the research discussed has all led to the conclusion that there is no difference in the performance of ethical investment mutual funds and the other conventional investment mutual funds. A study done in Holland and attempting to compare the performance of the Dutch social investment mutual funds with that of the conventional funds uncovered a slight difference. However, like all the other, the difference was too small to be considered as being statistically relevant (Scholtens, 2005). Not even such a research comparing seven European countries, namely Belgium, Germany, Netherlands, Norway, Sweden, Switzerland and United Kingdom, uncovered any conclusive evidence. Although there were many limitations that occurred during this research, there were many methods of analysis that were used that attempted to minimize these limitations.

Conclusion

The major question is whether social screens affect the performance of the investment mutual funds. There is a whole hoard of literature that has been performed by different authors. Most of the literature as we have already seen has come up with the same conclusion. Whether the studies have been conducted in the United States, the United Kingdom, Canada, Australia, or other European countries, there seems to be a consensus among researchers that although there is a slight difference that seemed to reflect that ethical investment mutual funds tend to out perform their counterparts, the results have been small and largely statistically irrelevant. There are many areas of the socially investment mutual funds in the world that have not been accessed. A study into these areas may reveal data that may be conclusive.

  The limitations for the operations of the investment mutual funds in general have not been set to their countries of origin. Moreover, their investment activities were analyzed over the range of countries that they operated in. One study compared 103 mutual investment funds whereas another considered 88 in over eight countries. Whereas the sample size is large, the data remains inconclusive. There has been the use of a variety of data collection methods in order to vary the research from what others had done. Additionally, statistical methods were also varied to discover whether any differences would be found. The initial researches into the topic usually considered the Jensen’s alpha approach or the Sharpe approach in order to draw conclusions from the data they collected. Subsequent researchers attempted to use single factor methods together with multifactor methods. However, the results that they found were still consistent with the ones that were produced by the previous methods. Later, researcher used the conditional approaches that bordered on varying risks and estimates in time. This approach did no better than all the others before it.

When theorists are considered, without any statistical data to back their claims, they cite a better performance for the ethical investment mutual funds than that of other conventional investment mutual funds. However, other theorists also advocate for the opposite; that conventional mutual investment funds are better performing. The reason they give is that since the ethical investment mutual funds have social screens that direct their investments, which their counterparts do not. Therefore, if there was an opportunity and the company portfolio was not socially responsible, then the ethical mutual fund would pass up the opportunity. This would leave the other conventional investment mutual funds to capitalize on it. Thus, the ethical mutual fund misses out on the chance to diversify. Furthermore, the investment that goes into the screens so that companies are deemed socially responsible for investment are also avenues that channel returns away from the funds. Further, there is the notion that the conventional investment mutual funds do not have any constraints and hence are capable of making under hand deals so as to cover any losses. The same is not true for the ethical investment mutual funds, as they would not capitalize on any opportunities that may be deemed as being unethical. Therefore, in hard economic times like in recessions, while the ethical investment mutual funds make losses, the conventional ones may contort themselves in a manner that will allow them to make profits.

Those theorists that claim that the ethical investment mutual funds are more profitable and out perform their counterparts cite the fact that the social responsible companies have a stronger culture. This means that they have a strong foundation that includes a strong management. In the long run, when the less socially responsible companies are weeded out, the responsible ones are already going to be an advantage. This assumption is based on the fact that as the consumer becomes more informed, all corporate will be required to be more socially responsible in order to remain competitive. Socially responsible corporate will attract more investment opportunities from ethical investment mutual funds and thus will out perform the conventional ones.

This paper has considered the theories that have been advanced and researches that have been conducted in a number of countries and using multiple investment mutual funds. First, the conventional indices that have been used in all research conducted have not favored the social investment mutual funds. In contrast, the socially responsible indices have favored both the social investment mutual funds and conventional investment mutual funds. This is because there are no constraints that curtail the limits of the conventional investment mutual funds. Therefore, those that limit the ethical investment mutual funds do not apply to the conventional ones. All researches that have been done have found no conclusive evidence as to the performance of the ethical and conventional investment mutual funds. Imposing ethical constraints cannot therefore be seen as posing weaker investment performance. Skepticism on the part of most investors in the countries of research was based on whether there are losses of any kind that could be associated with investing in social investment mutual funds. The answer to their skepticism is that no risks are involved.

The most interesting thing from the discussions above is that there is no distinct style in which the ethical investment mutual funds distinguish themselves from the conventional investment mutual funds. Their modes of investment seem to be similar and although there is claim that ethical screening is done before the ethical investment mutual funds invest into any company, there is no significant indication that this affects the performance of the two types of mutual funds. In fact, there is more of a correlation in all researches between the conventional market indices and the ethical investment mutual funds than there is between them and ethical market indices. Claims have been made that may be there needs to be transparency on the part of the investment mutual funds on the way that they disseminate their information since there seems to be a defect in the results gotten. In answering the question posed at the beginning of this paper, it is inevitable to conclude that ethical investment mutual funds do not perform better than conventional investment mutual funds as evidence has shown.

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