Description
The purpose of this paper is to investigate whether socially responsible investment (SRI)
is less sensitive to market downturns than conventional investments; the legal implications for fund
managers and trustees; and possible legislative reforms to allow conventional funds more scope to
invest in SRI.
Accounting Research Journal
Should funds invest in socially responsible investments during downturns?: Financial and
legal implications of the fund manager's dilemma
Richard Copp Michael L. Kremmer Eduardo Roca
Article information:
To cite this document:
Richard Copp Michael L. Kremmer Eduardo Roca, (2010),"Should funds invest in socially responsible
investments during downturns?", Accounting Research J ournal, Vol. 23 Iss 3 pp. 254 - 266
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Should funds invest in socially
responsible investments during
downturns?
Financial and legal implications
of the fund manager’s dilemma
Richard Copp
School of Accountancy, Queensland University of Technology,
Brisbane, Australia, and
Michael L. Kremmer and Eduardo Roca
Grif?th Business School, Grif?th University, Nathan, Australia
Abstract
Purpose – The purpose of this paper is to investigate whether socially responsible investment (SRI)
is less sensitive to market downturns than conventional investments; the legal implications for fund
managers and trustees; and possible legislative reforms to allow conventional funds more scope to
invest in SRI.
Design/methodology/approach – The paper uses the market model to estimate betas over the past
15 years for SRI funds and conventional investment funds during economic downturns, as distinct
from during more “normal” (non-recessionary) economic times.
Findings – The beta risk of SRI, both in Australia and internationally, increases more than that of
conventional investment during economic downturns. Traditional fund managers and trustees in
Australia are therefore likely to breach their ?duciary duties if they go long – or remain long – in SRI
funds during economic downturns, unless relevant legislation is reformed.
Research limitations/implications – The methodology assumes that alpha and beta in the
market model are constant. Second, it categorises the state of the market into “normal” economic
conditions and downturns using dummy variables. More sophisticated techniques could be used in
future research.
Practical implications – The current law would prevent conventional funds from investing in SRI.
If SRI is viewed as socially desirable, useful legislative reforms could include explicitly overriding the
common law to allow conventional funds to invest in SRI; introducing a 150 percent tax deduction or
investment allowance for SRI; and allowing SRI sub-funds to obtain deductible gift recipient status
from the Australian Tax Of?ce and other taxation authorities.
Originality/value – The accurate assessment of risk in SRIs is an area which, despite its serious
legal implications, is yet to be subjected to rigorous empirical investigation.
Keywords Investment funds, Social responsibility, Fund management, Economic conditions, Australia
Paper type Research paper
1. Introduction
Socially responsible investment (SRI) is the process of selecting or managing
investments with the aimnot of maximizing investor returns for given risk per se, but of
optimising these parameters subject to social, environmental and ethical constraints
(Oxford Business Knowledge, 2007, p. 5). The aggregate value of SRI internationally
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
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Accounting Research Journal
Vol. 23 No. 3, 2010
pp. 254-266
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309611011092583
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has grown considerably over the past 30 years, to the extent that SRI is now keenly
encouraged by the United Nations and other supra-national organisations. Speci?c
share indices based on SRI, such as the Dow Jones sustainability index (DJSI) and
London’s FTSE4GOOD index, have developed, along with specialised research
organisations such as the Sustainable Investment Research Institute. In the USA, SRI
assets are worth US$2.71 trillion (Social Investment Forum: United States, 2007); in
Canada, they are worth some C$503 billion or US$471 billion (Canada Social Investment
Organisation, 2006); the UK market is valued at e781 billion or US$1.17 trillion
(European Social Investment Forum, 2006); and Japan’s SRI markets are worth up to
¥840 billion or US$7.3 billion (Social Investment Forum: Japan, 2007). The market in
Australia is as yet comparatively undeveloped, with total assets invested in SRI are
valued at A$19.4 million or US$17.3 million (Responsible Investment Association of
Australasia, 2007).
While the sector remained a relatively small part of investors’ portfolios and equity
markets were generally performing well, industry stakeholders such as investment
fund trustees, their advisory boards and managers, investors, policy makers,
legislators and academicians, could be content to leave a number of potentially
problematic issues unresolved. These issues include whether SRI performs as well as
conventional investment during a market downturn; if not, whether conventional
investment fund trustees and their advisory boards risk breaching their ?duciary
duties at a time when conventional investment returns slump; and whether the law in
this area is in need of practical reform. But now that the SRI sector has come of age and
in the wake of the most catastrophic worldwide market downturn since the Great
Depression, industry stakeholders can no longer afford to ignore these issues. The need
to address them provides the motivation for this research. If they are left unresolved,
we identify the risks for conventional fund trustees and their advisory boards. If
industry stakeholders choose to address these issues, our paper provides some
practical suggestions for their resolution, in Section 6 entitled “Practical implications”.
This paper examines:
.
the extent to which the risk-adjusted returns on SRI investments are similar to
those of conventional investments during economic downturns;
.
whether SRI is, as posited by some previous studies, less risky and sensitive to
economic downturns than conventional investments; and
.
our empirical ?ndings on SRI performance in light of the existing law on
conventional trustees’ ?duciary duties, to ascertain whether the current law
requires reform.
As discussed in the following section, the existing literature is not clear as to whether
SRI would perform better than conventional investment during market downturns.
The contribution of this paper is to provide new evidence as to the investment
performance of SRI during market downturns. This new evidence has disturbing legal
implications for conventional fund trustees who seek to invest in SRI during market
downturns because it shows that, by doing so, they risk breaching their ?duciary
duties. These legal implications of SRI performance by conventional fund trustees
during market downturns have not been explored in the literature to date. This paper is
an attempt to address this important shortcoming in the literature.
Socially
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2. Prior literature
Most empirical studies around the world have reported that, before the global ?nancial
crisis (GFC), SRI funds internationally performed as well, in terms of annual
risk-adjusted returns, as conventional (non-SRI) funds. This ?nding appeared to apply in
the USA (Diltz, 1995; Guerard, 1997; Sauer, 1997; Gregory et al., 1997; Bauer et al., 2005;
Hamilton et al., 1993; Statman, 2000; Goldreyer et al., 1999; Renneboog et al., 2007, 2008;
Schroder, 2007); in the UK (Gregory et al., 1997; Schroder, 2007); as between SRI and
conventional funds from the USA, the UK and Germany (Bauer et al., 2005); as between
such funds from the UK, Germany, Sweden and The Netherlands (Kreander et al., 2005);
and – albeit with some variation, depending on the time period studied – in Australia
(Bauer et al., 2006). All of this empirical evidence relates to periods before the current GFC.
Anecdotal evidence, however, suggests that the period since the GFC has seen
signi?cantly lower investment returns and higher investment risks. In contrast, other
studies such as Benson and Humphrey (2007) and Bollen (2007) posit that SRIs should be
less sensitive to market downturns than conventional investments, because investors in
SRI are investing not simply for pro?ts, but also for other social or ethical objectives that
provide them with utility. For this reason, these studies suggest that, even in tight
economic times – as in the recent GFC – SRI investors tend not to abandon their SRI
investments (as they well might their conventional investments), implying arguably
that SRI funds are not so risky as conventional funds. The ?rst two objectives of this
paper represent our attempt to resolve these apparently inconsistent ?ndings in the
literature.
From a legal perspective, if the risk-adjusted returns on SRI are similar to
conventional investments in economic downturns, or if SRI is less risky in economic
downturns than conventional investments, then conventional fund managers and
trustees are free to invest in SRI – and the question could be asked, at least in Australia,
why they do not do so more. If, on the other hand, the risk-adjusted returns on SRI are
signi?cantly less than those on conventional investments in economic downturns, or if
SRI is riskier in economic downturns than conventional investments, it begs the
question of whether conventional fund managers and trustees would breach their
?duciary duties by investing in SRI.
3. Methodology and data
We conduct our analysis within the context of the well-known market model or capital
asset pricing model. The capital asset pricing model simply states that the systematic
or non-diversi?able risk, beta (b), of a portfolio composed of a subset of the assets of
the market portfolio is:
b
i
¼
covðR
i
; R
m
Þ
varðR
m
Þ
ð1Þ
where the covariance covðR
i
; R
m
Þ between the return on the industry portfolio i and the
market portfolio R
m
is inversely related to the variance varðR
m
Þ of the market portfolio.
Given that the covariance between the market portfolio and itself is simply varðR
m
Þ,
the beta of the market portfolio is by de?nition equal to one, against which the sector
portfolio can be compared. A market portfolio which also has a beta equal to one
(b ¼ 1), is considered a neutral investment; a market portfolio with a beta less than one
(b , 1) is considered a defensive or a relatively safe investment; while one with a beta
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greater than one (b . 1) is considered to be an aggressive or relatively risky
investment. The market model can be used to estimate the unconditional beta for any
asset using the following regression equation:
R
it
¼ m
t
þb
t
R
mt
þ1
it
; t ¼ 1; . . . ; T ð2Þ
where R
it
is the return series of a composite sector index for sector i; R
mt
is the market
return index; and 1
it
is the disturbance term of mean zero, which is presumed to be
serially independent and homoscedastic. The intercept m
t
and slope b
t
coef?cients are
presumed to be consistent over time, and it is the slope coef?cient b
t
which provides an
estimate of the beta or systematic risk for sector i.
In practice, the estimation of equation (1) by ordinary least squares has proven to be
problematic. Many studies including Brooks et al. (1998) have found that beta is often
time-varying and, while the returns series are usually found to be serially independent,
the residuals are often found to be heteroscedastic and leptokurtic when compared to a
normal distribution. Time-varying betas can be estimated using multivariate
generalized autoregressive conditional heteroscedasticity (GARCH) models, recursive
regression or state space models. In the present case, it is not our intention to establish
the magnitude of beta at every point, but rather to distinguish between the average value
of beta when the returns are rising or falling. Accordingly, we add a dummy variable
that represents the state of the market, described later, to the market model regression:
R
it
¼ m þbR
mt
þvðR
mt
I
t21
Þ þ1
it
; t ¼ 1; . . . ; T ð3Þ
where v is the estimated coef?cient which measures the shifts in the slope of the
equation associated with negative returns in the previous period. Consequently, b is an
estimate of the systematic risk when returns are positive and the sector index is rising,
while (b þ v) is an estimate of the systematic risk when returns are negative and the
sector index is falling.
The problems associated with heteroscedasticity and leptokurtic residuals are
modeled using the “GARCH” model introduced by Bollerslev (1986) which we estimate
under the assumption that the residuals follow a t-distribution, rather than a normal
distribution. The result is that the time variation in the variance of the error term in
equation (3) is simultaneously estimated using the following equation:
s
2
t
¼ a þg1
2
t21
þds
2
t21
ð4Þ
This insures that the estimated coef?cients in equation (3) are ef?cient and can be
interpreted in the normal manner while the estimated coef?cients in equation (4) have
no practical implications for our analysis.
We use weekly closing price of four price indexes obtained from Morningstar which
run from 7 January 1994 to 29 May 2009 providing a total 804 observations. The ?rst of
these indexes – the DowJones total stock market (DJTM) index world (DJTM-World) –
captures price movement in the world’s traditional equity markets, while the second
index – the DJSI-World – is a subset of the ?rst that captures price movements in a
portfolio comprised of equities in SRI. The third index – the DJTM-Australia –
represents price movement in Australian traditional equity market, and the fourth – the
DJSI-Australia – captures price movements in a portfolio comprised of Australian
equities involved in SRI businesses.
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We transform each of these four indices into continuously compounded returns
calculated as:
R
t
¼ ln
P
t
P
t21
and create two idiosyncratic dummy variables I
t
for DJTM-World and
DJTM-Australia, respectively. Each of these idiosyncratic dummy variables takes
the value 1 if the relevant return series is less than zero (R
t
, 0) indicative of “bad
news” and economic downturn, or 0 when the returns series is greater than or equal to
zero (R
t
$ 0) indicative of “good news” or more “normal” economic conditions, in line
with previous literature (see, for instance, Woodward and Anderson (2009), Lunde and
Timmerman (2004), Maheu and McCurdy (2000), among others).
4. Findings
We examined the performance of SRIs against conventional investments, both in
Australia and internationally, in terms of total risk-adjusted returns. Table I presents a
summary of our ?ndings in terms of relevant statistics. It can be seen fromthis table that
SRIs internationally (DJSI-World) resulted in higher total risk-adjusted returns
(5.2 percent pa on average) than conventional investments (DJTM-World) [4.8 percent pa
on average]. With regard to investment just in Australia, however, our results showed
that, prior to the GFC, SRIs (DJSI-Australia) signi?cantly under-performed conventional
investments (DJTM-Australia) in terms of total risk-adjusted returns (an average of
5.8 percent pa, compared with 7.1 percent pa, respectively). These results suggested that,
even before the GFC, prudent fund managers would have been well advised to carefully
consider precisely where in Australia they placed their investors’ SRI funds. Since the
GFC, it appeared from our preliminary research that, internationally, SRI had
signi?cantly under-performed conventional investment in terms of total risk-adjusted
returns (26.6 percent pa on average, as opposed to 25.7 percent pa, respectively).
The results from our market model testing of equation (6) are presented in Table II,
which is divided into three panels. Panel A shows the estimated coef?cients of the
mean equation, and the relevant t-statistics; Panel B sets out the estimated coef?cients
of the variance equation and Panel C displays the model validation statistics for the
mean equation.
Turning ?rst to Panel C, the summary statistics, we ?nd that, in each case, the null
hypothesis – that residuals of the three models are free from autocorrelation in both
DJSI-Australia DJTM-Australia DJSI-World DJTM-World
Pre-GFC sub-period
Mean 0.204 0.211 0.125 0.115
SD 3.463 2.954 2.363 2.379
Mean/SD 0.058 0.071 0.052 0.048
GFC sub-period
Mean 20.291 20.368 20.327 20.302
SD 8.096 6.710 4.946 5.335
Mean/SD 20.036 20.055 20.066 20.057
Table I.
Summary statistics for
preliminary analysis –
annualised total
risk-adjusted returns
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the ?rst and second moments, as indicated by the Q-stat and H-stat tests, respectively
(with p-values in italics) – cannot be rejected. In each case, the Durbin-Watson statistic
indicates that the residuals are free fromauto-correlation at the ?rst lag. The coef?cient
of determination, R
2
, measures the variability in the dependent variable – the returns
on sustainable investments, in all but Columns (7) and (8) – that are explained by
the variability of the independent variable, the returns on the market. In the ?rst case,
the international equity markets, 93 percent of the variations in the returns on
sustainable investment are explained by returns on the market portfolio (TMW). In
second case, the Australian markets, 58 percent of this variation is explained by the
model; and, in the third case, only 11 percent of the variation in sustainable investment
in the Australian market is explained by variation in the international markets for
sustainable investments.
Panel B contains the estimated coef?cients of the variance equations and their
respective t-statistics. The results here are as one would expect – the intercept terms, a
are not signi?cantly different from zero while the ARCH g and GARCH d terms are
signi?cant in every case. These two terms sum to approximately one indicating that,
?rstly, volatility shocks are quite persistent; and second, the estimate of the number of
degrees of freedom for the t-distribution used to model the residuals is quite small,
revealing that in every case this distribution is more appropriate than the normal
distribution.
Perhaps most importantly, Panel A sets out the estimated coef?cients of beta for
the relevant regressions. The ?rst two columns contain the estimates in relation to
the international market for SRIs and conventional investments. As can be seen, the
estimate of beta is highly signi?cant and indistinguishable from 1, i.e. the beta of
the whole market. The estimated coef?cient on the dummy variable indicative of bad
SIW on TMW SIA on TMA SIA on SIW TMA on TMW SIA on TMW
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Coef t-Stat Coef t-Stat Coef t-Stat Coef t-Stat Coef t-Stat
Panel A The mean equation: R
it
¼ m þbR
mt
þvðR
mt
I
t21
Þ þ1
it
m 0.000 1.051 0.000 20.233 0.002 2.221 0.002 3.144 0.002 2.193
b 0.992 87.925 1.102 44.360 0.265 4.676 0.355 9.020 0.263 4.827
v 0.043 2.733 20.069 22.129 0.157 2.301 20.021 20.363 0.164 2.202
Panel B The variance equation: s
2
t
¼ a þg1
2
t21
þds
2
t21
a 0.000 1.784 0.000 1.259 0.000 1.494 0.000 1.215 0.000 1.558
g 0.098 4.141 0.080 4.333 0.070 3.710 0.050 3.440 0.075 3.789
d 0.891 36.74 0.920 56.50 0.921 41.41 0.939 45.26 0.915 38.98
t-Dist 9.666 2.709 8.858 3.107 8.802 3.510 9.119 2.938 9.071 3.484
Panel C Summary statistics
R
2
0.933 0.581 0.112 0.297 0.100
DW 2.251 2.245 2.092 2.217 2.108
Q-stat(12)
a
17.63 0.12 15.19 0.23 13.30 0.35 15.02 0.24 14.70 0.26
H-stat(12)
a
9.992 0.62 3.986 0.98 12.72 0.39 18.62 0.10 13.48 0.34
Notes:
a
The Q-stat and H-stat use the Ljung-box test on the residuals and squared residuals up to the
12th lag: p-values in italics; practically the same results are obtained when the market model is
estimated based on risk premia; the alphas are all insigni?cantly different from zero for both SRI and
conventional investments in the Australian and international cases at the 95 percent level
Table II.
Estimates of coef?cients
of equation (6)
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news is positive and signi?cantly different from zero, indicating that beta increases
in response to bad news, i.e. to a downturn in the market.
Columns (3) and (4), which focus on the Australian market for SRIs and conventional
investments, show a somewhat different picture. Again, the beta coef?cient is highly
signi?cant and larger than one in magnitude, indicating that, under normal economic
conditions, investing in SRIs in Australia is riskier than investing in conventional
investments. The dummy variable is also signi?cant but has a negative sign,
indicating at ?rst glance that investing in SRIs in Australia is slightly less risky (though
only just) during an economic downturn than investing in conventional equities in
Australia.
Columns (9) and (10) show the results of regressing Australian SRI returns against
conventional investment returns internationally. In Column (9), the coef?cient for beta
is signi?cant at 0.263, indicating that, from a world perspective (e.g. that of a fund
manager in New York), Australian SRIs are relatively low risk, compared with
conventional investments internationally. The dummy variable in Column (9) is, at
0.164, marginally positive and signi?cant, indicating that when the world experiences
an economic downturn, the systematic risk of Australian SRIs increases marginally.
This result is consistent with the estimates shown in Columns (5) and (6), in which
we model Australian SRIs in the context of SRIs internationally. This model differs
slightly from the preceding two in that dummy variables indicative of bad news in the
previous period have been included for both the international and the Australian SRI
markets. This addition was not necessary in respect of the other two models because
the markets’ two return series are so highly correlated that the second dummy variable
series would be redundant, indicative as it would be of the same changes in returns.
The estimate of the beta in this context is again small though signi?cant, indicating
that under “normal” economic conditions, SRIs in Australia are less risky than SRIs
internationally. In terms of the two dummy variables in this model, the estimated
coef?cient in respect of the dummy variable for an economic downturn in Australia
was not signi?cant; however, the dummy variable for an economic downturn
internationally was marginally positive and is statistically signi?cant.
For the sake of completeness, Columns (7) and (8) show the results of modeling
conventional investment in Australia as a subset of conventional investment
internationally. The signi?cant beta coef?cient shows that conventional investment
in Australia is less risky on average than conventional investment internationally.
Again, this models included dummy variables indicative for “bad” news (an economic
downturn) in both the Australian and international markets. Here the estimated
coef?cients in the model for conventional investment are insigni?cantly different
from zero, indicating that when international stock markets decline, conventional
investment returns in Australia follow those of international conventional investments
downward.
5. Research limitations
The model that we have estimated in this study is not without limitations. The
methodology assumes that alpha and beta in the market model are constant. This is the
subject of ongoing research. Second, it categorises the state of the market into “normal”
economic conditions and downturns using dummy variables. More sophisticated
techniques could be used in future research.
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The fact that we have found statistically signi?cant differences in the betas between
periods of increasing and decreasing returns suggests that the betas are in fact
time-varying to some extent. In the present case, this is not in itself particularly
important – “average” betas (which are in effect what we have estimated here) have
been shown to vary very little from the averages of time-varying betas estimated using
more complex methods (Brooks et al., 1998).
Consequently, we believe that the simplicity of the model presented here has much
to recommend it in terms of accessibility. Moreover, given that it is not our intention to
obtain the best possible estimates of beta or to forecast returns, but to simply establish
if they are affected by the direction of the market, it is unlikely that a more complex
method of analysis would produce results that differ in any relevant way from those
presented here.
Nevertheless, it would be possible to investigate the causes of the observed changes
in beta in these markets using more complex methods. Recall that beta is de?ned, as in
equation (2) as the ratio of the covariance between the industry portfolio and the
market and the variance of the market:
b
i
¼
covðR
i
; R
m
Þ
varðR
m
Þ
ð5Þ
The model used here estimates the differences in the magnitude in this ratio when the
market is rising and falling. These differences can be caused by changes in the
covariance between the industry and the market, the variance of the market, or both.
These effects could be distinguished using a multivariate version of the GARCHmodel,
which allows the variance of the two series and the covariance between them to be
estimated at every point of time. This would then allow the calculation of time-varying
betas. The important point is that this more complex model would only serve to
explain the source of the difference in beta that we have observed, in terms of the
impact of good and bad news upon the covariances and variances, rather than upon the
ratio of the two. While this is not without interest, it would add little to the topic at
hand and we leave it for future research.
6. Practical implications
Our ?ndings have important implications for fund managers. First, for an Australian
fund manager whose trust deed or taxation status limits it to investments
within Australia, SRIs are normally riskier than conventional investments. During
an economic downturn when conventional equity investment returns decline, SRI
returns also decline (though interestingly, not by as much, which is consistent to
some extent with Benson and Humphrey (2007) and Bollen (2007)). Second, for a fund
manager – whether based in Australia or overseas – who is able to invest globally, SRIs
are normally as riskyas conventional investments, but become riskier thanconventional
investments when the world enters an economic downturn such as the GFC. Having said
this, if the fund wishes to remain long in SRIs during an economic downturn, SRIs in
Australia are generally safer than SRIs in other countries.
Furthermore, these ?ndings have compelling legal implications for conventional
fund managers and trustees. On an economic viewof trust law, a traditional investment
trustee has a duty to maximize risk-adjusted returns (Boasson et al., 2004, p. 56;
Martin, 2009, pp. 1, 2 and 18). Moreover, a fund trustee risks breaching its ?duciary
Socially
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duties if it sacri?ces adequate risk-adjusted returns in the pursuit of non-?nancial goals
such as SRI (Ali and Gold, 2002, pp. 18, 31)[1]. Also, there is evidence that many fund
trustees and managers do fear the risk of lawsuits for breaches of their ?duciary or
statutory duties if they invest in SRIs (Lane, 2006, pp. 33-4), or at the least, believe that
there is less risk of lawsuits if they invest in conventional (non-SRI) investments (Dobris,
2008, p. 761). Williams and Conley (2005a, p. 546n) even found that 55 percent of the
largest mutual funds in the US vote against all social and environmental proposals;
15 percent vote against nearly all such proposals; and 30 percent abstain from voting.
Nor are the fundamental problems solved by using a combination of traditional Master
Trusts and SRI sub-trusts since, unless the objects of a traditional Master Trust have
been varied in accordance with a power of variation in the trust deed, the Master Trust is
likely to be infected by the breach of duty.
Much, of course, depends on the objectives set out in the relevant trust deed (Finn,
1989)[2]. Other things being equal, existing traditional (non-SRI) trusts cannot simply
invest in SRIs if their deeds do not allow this. If they purport to do so, traditional fund
trustees and managers do risk breaching their ?duciary or statutory duties not to
unconscionably exercise a power for a purpose not justi?ed by the trust deed[3]; or a
statute (e.g. invest in SRIs if the ability to do so is not permitted by the trust deed or
legislation).
Such an exercise is likely to constitute a fraud on a power; not acting in the best
interests of all bene?ciaries, and perhaps pursuing its own interests[4]; not acting in
good faith, and possibly misusing property held in a ?duciary capacity or engaging in
con?icts of duty and interest[5]; and/or failing to treat bene?ciaries of different classes
fairly – for example, by advantaging some bene?ciaries or bene?ciary classes at the
expense of others (Finn, 1977, Chapter 10).
Unless the trust deed contains an explicit power of variation (and many older trust
deeds do not), such investment in SRIs could trigger a resettlement of the trust, with a
concomitant substantial capital gains tax bill if the trust was settled after September
1985 (Australian Taxation Of?ce, 1999). While this would not occur if the trust is a
tax-exempt charitable purpose trust, most investment trusts in this context are not. It is
this prospective pecuniary cost which is far more likely to precipitate a lawsuit than
any umbrage about a breach of ?duciary responsibilities per se.
This situation is likely to continue unless perhaps relevant legislation is reformed to
enhance the attractiveness of SRI as an investment. Whether this is viewed as desirable
ultimately depends on the type of society we want – that is, on societal values and the
political will for legislative reform. Possible reforms could include:
.
allowing conventional fund managers and trustees to invest in SRI without
triggering resettlement of their trusts, together with the resultant massive capital
gains tax bills this would produce;
.
tax concessions for SRI (e.g. a 150 percent tax deduction or investment allowance
for SRI; and
.
allowing SRI sub-funds to obtain deductible gift recipient status from the
Australian Tax Of?ce and other taxation authorities.
A detailed analysis of such proposals must, however, be the subject of future research.
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Notes
1. See also, for example, the principles laid down in Vatcher v. Paull [1915] AC 372, 378; Chan v.
Zacharia [1984] 154 CLR 178, 198 per Deane J; Keech v. Sandford (1726) Cas. T K 61; and
Chief Commissioner of Stamp Duties (NSW) v. Buckle and Others (1998) 98 ATC 4097.
2. See also Hospital Products Ltd v. United States Surgical Corp (1984) 156 CLR 41,
68 per Gibbs CJ.
3. Vatcher v. Paull [1915] AC 372, 378.
4. Chan v. Zacharia [1984], 154 CLR 178, 198 per Deane J.
5. Keech v. Sandford [1726] Cas. T K 61.
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Corresponding author
Eduardo Roca can be contacted at: e.roca@grif?th.edu.au
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doc_979965321.pdf
The purpose of this paper is to investigate whether socially responsible investment (SRI)
is less sensitive to market downturns than conventional investments; the legal implications for fund
managers and trustees; and possible legislative reforms to allow conventional funds more scope to
invest in SRI.
Accounting Research Journal
Should funds invest in socially responsible investments during downturns?: Financial and
legal implications of the fund manager's dilemma
Richard Copp Michael L. Kremmer Eduardo Roca
Article information:
To cite this document:
Richard Copp Michael L. Kremmer Eduardo Roca, (2010),"Should funds invest in socially responsible
investments during downturns?", Accounting Research J ournal, Vol. 23 Iss 3 pp. 254 - 266
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Should funds invest in socially
responsible investments during
downturns?
Financial and legal implications
of the fund manager’s dilemma
Richard Copp
School of Accountancy, Queensland University of Technology,
Brisbane, Australia, and
Michael L. Kremmer and Eduardo Roca
Grif?th Business School, Grif?th University, Nathan, Australia
Abstract
Purpose – The purpose of this paper is to investigate whether socially responsible investment (SRI)
is less sensitive to market downturns than conventional investments; the legal implications for fund
managers and trustees; and possible legislative reforms to allow conventional funds more scope to
invest in SRI.
Design/methodology/approach – The paper uses the market model to estimate betas over the past
15 years for SRI funds and conventional investment funds during economic downturns, as distinct
from during more “normal” (non-recessionary) economic times.
Findings – The beta risk of SRI, both in Australia and internationally, increases more than that of
conventional investment during economic downturns. Traditional fund managers and trustees in
Australia are therefore likely to breach their ?duciary duties if they go long – or remain long – in SRI
funds during economic downturns, unless relevant legislation is reformed.
Research limitations/implications – The methodology assumes that alpha and beta in the
market model are constant. Second, it categorises the state of the market into “normal” economic
conditions and downturns using dummy variables. More sophisticated techniques could be used in
future research.
Practical implications – The current law would prevent conventional funds from investing in SRI.
If SRI is viewed as socially desirable, useful legislative reforms could include explicitly overriding the
common law to allow conventional funds to invest in SRI; introducing a 150 percent tax deduction or
investment allowance for SRI; and allowing SRI sub-funds to obtain deductible gift recipient status
from the Australian Tax Of?ce and other taxation authorities.
Originality/value – The accurate assessment of risk in SRIs is an area which, despite its serious
legal implications, is yet to be subjected to rigorous empirical investigation.
Keywords Investment funds, Social responsibility, Fund management, Economic conditions, Australia
Paper type Research paper
1. Introduction
Socially responsible investment (SRI) is the process of selecting or managing
investments with the aimnot of maximizing investor returns for given risk per se, but of
optimising these parameters subject to social, environmental and ethical constraints
(Oxford Business Knowledge, 2007, p. 5). The aggregate value of SRI internationally
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
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Accounting Research Journal
Vol. 23 No. 3, 2010
pp. 254-266
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309611011092583
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has grown considerably over the past 30 years, to the extent that SRI is now keenly
encouraged by the United Nations and other supra-national organisations. Speci?c
share indices based on SRI, such as the Dow Jones sustainability index (DJSI) and
London’s FTSE4GOOD index, have developed, along with specialised research
organisations such as the Sustainable Investment Research Institute. In the USA, SRI
assets are worth US$2.71 trillion (Social Investment Forum: United States, 2007); in
Canada, they are worth some C$503 billion or US$471 billion (Canada Social Investment
Organisation, 2006); the UK market is valued at e781 billion or US$1.17 trillion
(European Social Investment Forum, 2006); and Japan’s SRI markets are worth up to
¥840 billion or US$7.3 billion (Social Investment Forum: Japan, 2007). The market in
Australia is as yet comparatively undeveloped, with total assets invested in SRI are
valued at A$19.4 million or US$17.3 million (Responsible Investment Association of
Australasia, 2007).
While the sector remained a relatively small part of investors’ portfolios and equity
markets were generally performing well, industry stakeholders such as investment
fund trustees, their advisory boards and managers, investors, policy makers,
legislators and academicians, could be content to leave a number of potentially
problematic issues unresolved. These issues include whether SRI performs as well as
conventional investment during a market downturn; if not, whether conventional
investment fund trustees and their advisory boards risk breaching their ?duciary
duties at a time when conventional investment returns slump; and whether the law in
this area is in need of practical reform. But now that the SRI sector has come of age and
in the wake of the most catastrophic worldwide market downturn since the Great
Depression, industry stakeholders can no longer afford to ignore these issues. The need
to address them provides the motivation for this research. If they are left unresolved,
we identify the risks for conventional fund trustees and their advisory boards. If
industry stakeholders choose to address these issues, our paper provides some
practical suggestions for their resolution, in Section 6 entitled “Practical implications”.
This paper examines:
.
the extent to which the risk-adjusted returns on SRI investments are similar to
those of conventional investments during economic downturns;
.
whether SRI is, as posited by some previous studies, less risky and sensitive to
economic downturns than conventional investments; and
.
our empirical ?ndings on SRI performance in light of the existing law on
conventional trustees’ ?duciary duties, to ascertain whether the current law
requires reform.
As discussed in the following section, the existing literature is not clear as to whether
SRI would perform better than conventional investment during market downturns.
The contribution of this paper is to provide new evidence as to the investment
performance of SRI during market downturns. This new evidence has disturbing legal
implications for conventional fund trustees who seek to invest in SRI during market
downturns because it shows that, by doing so, they risk breaching their ?duciary
duties. These legal implications of SRI performance by conventional fund trustees
during market downturns have not been explored in the literature to date. This paper is
an attempt to address this important shortcoming in the literature.
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2. Prior literature
Most empirical studies around the world have reported that, before the global ?nancial
crisis (GFC), SRI funds internationally performed as well, in terms of annual
risk-adjusted returns, as conventional (non-SRI) funds. This ?nding appeared to apply in
the USA (Diltz, 1995; Guerard, 1997; Sauer, 1997; Gregory et al., 1997; Bauer et al., 2005;
Hamilton et al., 1993; Statman, 2000; Goldreyer et al., 1999; Renneboog et al., 2007, 2008;
Schroder, 2007); in the UK (Gregory et al., 1997; Schroder, 2007); as between SRI and
conventional funds from the USA, the UK and Germany (Bauer et al., 2005); as between
such funds from the UK, Germany, Sweden and The Netherlands (Kreander et al., 2005);
and – albeit with some variation, depending on the time period studied – in Australia
(Bauer et al., 2006). All of this empirical evidence relates to periods before the current GFC.
Anecdotal evidence, however, suggests that the period since the GFC has seen
signi?cantly lower investment returns and higher investment risks. In contrast, other
studies such as Benson and Humphrey (2007) and Bollen (2007) posit that SRIs should be
less sensitive to market downturns than conventional investments, because investors in
SRI are investing not simply for pro?ts, but also for other social or ethical objectives that
provide them with utility. For this reason, these studies suggest that, even in tight
economic times – as in the recent GFC – SRI investors tend not to abandon their SRI
investments (as they well might their conventional investments), implying arguably
that SRI funds are not so risky as conventional funds. The ?rst two objectives of this
paper represent our attempt to resolve these apparently inconsistent ?ndings in the
literature.
From a legal perspective, if the risk-adjusted returns on SRI are similar to
conventional investments in economic downturns, or if SRI is less risky in economic
downturns than conventional investments, then conventional fund managers and
trustees are free to invest in SRI – and the question could be asked, at least in Australia,
why they do not do so more. If, on the other hand, the risk-adjusted returns on SRI are
signi?cantly less than those on conventional investments in economic downturns, or if
SRI is riskier in economic downturns than conventional investments, it begs the
question of whether conventional fund managers and trustees would breach their
?duciary duties by investing in SRI.
3. Methodology and data
We conduct our analysis within the context of the well-known market model or capital
asset pricing model. The capital asset pricing model simply states that the systematic
or non-diversi?able risk, beta (b), of a portfolio composed of a subset of the assets of
the market portfolio is:
b
i
¼
covðR
i
; R
m
Þ
varðR
m
Þ
ð1Þ
where the covariance covðR
i
; R
m
Þ between the return on the industry portfolio i and the
market portfolio R
m
is inversely related to the variance varðR
m
Þ of the market portfolio.
Given that the covariance between the market portfolio and itself is simply varðR
m
Þ,
the beta of the market portfolio is by de?nition equal to one, against which the sector
portfolio can be compared. A market portfolio which also has a beta equal to one
(b ¼ 1), is considered a neutral investment; a market portfolio with a beta less than one
(b , 1) is considered a defensive or a relatively safe investment; while one with a beta
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greater than one (b . 1) is considered to be an aggressive or relatively risky
investment. The market model can be used to estimate the unconditional beta for any
asset using the following regression equation:
R
it
¼ m
t
þb
t
R
mt
þ1
it
; t ¼ 1; . . . ; T ð2Þ
where R
it
is the return series of a composite sector index for sector i; R
mt
is the market
return index; and 1
it
is the disturbance term of mean zero, which is presumed to be
serially independent and homoscedastic. The intercept m
t
and slope b
t
coef?cients are
presumed to be consistent over time, and it is the slope coef?cient b
t
which provides an
estimate of the beta or systematic risk for sector i.
In practice, the estimation of equation (1) by ordinary least squares has proven to be
problematic. Many studies including Brooks et al. (1998) have found that beta is often
time-varying and, while the returns series are usually found to be serially independent,
the residuals are often found to be heteroscedastic and leptokurtic when compared to a
normal distribution. Time-varying betas can be estimated using multivariate
generalized autoregressive conditional heteroscedasticity (GARCH) models, recursive
regression or state space models. In the present case, it is not our intention to establish
the magnitude of beta at every point, but rather to distinguish between the average value
of beta when the returns are rising or falling. Accordingly, we add a dummy variable
that represents the state of the market, described later, to the market model regression:
R
it
¼ m þbR
mt
þvðR
mt
I
t21
Þ þ1
it
; t ¼ 1; . . . ; T ð3Þ
where v is the estimated coef?cient which measures the shifts in the slope of the
equation associated with negative returns in the previous period. Consequently, b is an
estimate of the systematic risk when returns are positive and the sector index is rising,
while (b þ v) is an estimate of the systematic risk when returns are negative and the
sector index is falling.
The problems associated with heteroscedasticity and leptokurtic residuals are
modeled using the “GARCH” model introduced by Bollerslev (1986) which we estimate
under the assumption that the residuals follow a t-distribution, rather than a normal
distribution. The result is that the time variation in the variance of the error term in
equation (3) is simultaneously estimated using the following equation:
s
2
t
¼ a þg1
2
t21
þds
2
t21
ð4Þ
This insures that the estimated coef?cients in equation (3) are ef?cient and can be
interpreted in the normal manner while the estimated coef?cients in equation (4) have
no practical implications for our analysis.
We use weekly closing price of four price indexes obtained from Morningstar which
run from 7 January 1994 to 29 May 2009 providing a total 804 observations. The ?rst of
these indexes – the DowJones total stock market (DJTM) index world (DJTM-World) –
captures price movement in the world’s traditional equity markets, while the second
index – the DJSI-World – is a subset of the ?rst that captures price movements in a
portfolio comprised of equities in SRI. The third index – the DJTM-Australia –
represents price movement in Australian traditional equity market, and the fourth – the
DJSI-Australia – captures price movements in a portfolio comprised of Australian
equities involved in SRI businesses.
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We transform each of these four indices into continuously compounded returns
calculated as:
R
t
¼ ln
P
t
P
t21
and create two idiosyncratic dummy variables I
t
for DJTM-World and
DJTM-Australia, respectively. Each of these idiosyncratic dummy variables takes
the value 1 if the relevant return series is less than zero (R
t
, 0) indicative of “bad
news” and economic downturn, or 0 when the returns series is greater than or equal to
zero (R
t
$ 0) indicative of “good news” or more “normal” economic conditions, in line
with previous literature (see, for instance, Woodward and Anderson (2009), Lunde and
Timmerman (2004), Maheu and McCurdy (2000), among others).
4. Findings
We examined the performance of SRIs against conventional investments, both in
Australia and internationally, in terms of total risk-adjusted returns. Table I presents a
summary of our ?ndings in terms of relevant statistics. It can be seen fromthis table that
SRIs internationally (DJSI-World) resulted in higher total risk-adjusted returns
(5.2 percent pa on average) than conventional investments (DJTM-World) [4.8 percent pa
on average]. With regard to investment just in Australia, however, our results showed
that, prior to the GFC, SRIs (DJSI-Australia) signi?cantly under-performed conventional
investments (DJTM-Australia) in terms of total risk-adjusted returns (an average of
5.8 percent pa, compared with 7.1 percent pa, respectively). These results suggested that,
even before the GFC, prudent fund managers would have been well advised to carefully
consider precisely where in Australia they placed their investors’ SRI funds. Since the
GFC, it appeared from our preliminary research that, internationally, SRI had
signi?cantly under-performed conventional investment in terms of total risk-adjusted
returns (26.6 percent pa on average, as opposed to 25.7 percent pa, respectively).
The results from our market model testing of equation (6) are presented in Table II,
which is divided into three panels. Panel A shows the estimated coef?cients of the
mean equation, and the relevant t-statistics; Panel B sets out the estimated coef?cients
of the variance equation and Panel C displays the model validation statistics for the
mean equation.
Turning ?rst to Panel C, the summary statistics, we ?nd that, in each case, the null
hypothesis – that residuals of the three models are free from autocorrelation in both
DJSI-Australia DJTM-Australia DJSI-World DJTM-World
Pre-GFC sub-period
Mean 0.204 0.211 0.125 0.115
SD 3.463 2.954 2.363 2.379
Mean/SD 0.058 0.071 0.052 0.048
GFC sub-period
Mean 20.291 20.368 20.327 20.302
SD 8.096 6.710 4.946 5.335
Mean/SD 20.036 20.055 20.066 20.057
Table I.
Summary statistics for
preliminary analysis –
annualised total
risk-adjusted returns
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the ?rst and second moments, as indicated by the Q-stat and H-stat tests, respectively
(with p-values in italics) – cannot be rejected. In each case, the Durbin-Watson statistic
indicates that the residuals are free fromauto-correlation at the ?rst lag. The coef?cient
of determination, R
2
, measures the variability in the dependent variable – the returns
on sustainable investments, in all but Columns (7) and (8) – that are explained by
the variability of the independent variable, the returns on the market. In the ?rst case,
the international equity markets, 93 percent of the variations in the returns on
sustainable investment are explained by returns on the market portfolio (TMW). In
second case, the Australian markets, 58 percent of this variation is explained by the
model; and, in the third case, only 11 percent of the variation in sustainable investment
in the Australian market is explained by variation in the international markets for
sustainable investments.
Panel B contains the estimated coef?cients of the variance equations and their
respective t-statistics. The results here are as one would expect – the intercept terms, a
are not signi?cantly different from zero while the ARCH g and GARCH d terms are
signi?cant in every case. These two terms sum to approximately one indicating that,
?rstly, volatility shocks are quite persistent; and second, the estimate of the number of
degrees of freedom for the t-distribution used to model the residuals is quite small,
revealing that in every case this distribution is more appropriate than the normal
distribution.
Perhaps most importantly, Panel A sets out the estimated coef?cients of beta for
the relevant regressions. The ?rst two columns contain the estimates in relation to
the international market for SRIs and conventional investments. As can be seen, the
estimate of beta is highly signi?cant and indistinguishable from 1, i.e. the beta of
the whole market. The estimated coef?cient on the dummy variable indicative of bad
SIW on TMW SIA on TMA SIA on SIW TMA on TMW SIA on TMW
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Coef t-Stat Coef t-Stat Coef t-Stat Coef t-Stat Coef t-Stat
Panel A The mean equation: R
it
¼ m þbR
mt
þvðR
mt
I
t21
Þ þ1
it
m 0.000 1.051 0.000 20.233 0.002 2.221 0.002 3.144 0.002 2.193
b 0.992 87.925 1.102 44.360 0.265 4.676 0.355 9.020 0.263 4.827
v 0.043 2.733 20.069 22.129 0.157 2.301 20.021 20.363 0.164 2.202
Panel B The variance equation: s
2
t
¼ a þg1
2
t21
þds
2
t21
a 0.000 1.784 0.000 1.259 0.000 1.494 0.000 1.215 0.000 1.558
g 0.098 4.141 0.080 4.333 0.070 3.710 0.050 3.440 0.075 3.789
d 0.891 36.74 0.920 56.50 0.921 41.41 0.939 45.26 0.915 38.98
t-Dist 9.666 2.709 8.858 3.107 8.802 3.510 9.119 2.938 9.071 3.484
Panel C Summary statistics
R
2
0.933 0.581 0.112 0.297 0.100
DW 2.251 2.245 2.092 2.217 2.108
Q-stat(12)
a
17.63 0.12 15.19 0.23 13.30 0.35 15.02 0.24 14.70 0.26
H-stat(12)
a
9.992 0.62 3.986 0.98 12.72 0.39 18.62 0.10 13.48 0.34
Notes:
a
The Q-stat and H-stat use the Ljung-box test on the residuals and squared residuals up to the
12th lag: p-values in italics; practically the same results are obtained when the market model is
estimated based on risk premia; the alphas are all insigni?cantly different from zero for both SRI and
conventional investments in the Australian and international cases at the 95 percent level
Table II.
Estimates of coef?cients
of equation (6)
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news is positive and signi?cantly different from zero, indicating that beta increases
in response to bad news, i.e. to a downturn in the market.
Columns (3) and (4), which focus on the Australian market for SRIs and conventional
investments, show a somewhat different picture. Again, the beta coef?cient is highly
signi?cant and larger than one in magnitude, indicating that, under normal economic
conditions, investing in SRIs in Australia is riskier than investing in conventional
investments. The dummy variable is also signi?cant but has a negative sign,
indicating at ?rst glance that investing in SRIs in Australia is slightly less risky (though
only just) during an economic downturn than investing in conventional equities in
Australia.
Columns (9) and (10) show the results of regressing Australian SRI returns against
conventional investment returns internationally. In Column (9), the coef?cient for beta
is signi?cant at 0.263, indicating that, from a world perspective (e.g. that of a fund
manager in New York), Australian SRIs are relatively low risk, compared with
conventional investments internationally. The dummy variable in Column (9) is, at
0.164, marginally positive and signi?cant, indicating that when the world experiences
an economic downturn, the systematic risk of Australian SRIs increases marginally.
This result is consistent with the estimates shown in Columns (5) and (6), in which
we model Australian SRIs in the context of SRIs internationally. This model differs
slightly from the preceding two in that dummy variables indicative of bad news in the
previous period have been included for both the international and the Australian SRI
markets. This addition was not necessary in respect of the other two models because
the markets’ two return series are so highly correlated that the second dummy variable
series would be redundant, indicative as it would be of the same changes in returns.
The estimate of the beta in this context is again small though signi?cant, indicating
that under “normal” economic conditions, SRIs in Australia are less risky than SRIs
internationally. In terms of the two dummy variables in this model, the estimated
coef?cient in respect of the dummy variable for an economic downturn in Australia
was not signi?cant; however, the dummy variable for an economic downturn
internationally was marginally positive and is statistically signi?cant.
For the sake of completeness, Columns (7) and (8) show the results of modeling
conventional investment in Australia as a subset of conventional investment
internationally. The signi?cant beta coef?cient shows that conventional investment
in Australia is less risky on average than conventional investment internationally.
Again, this models included dummy variables indicative for “bad” news (an economic
downturn) in both the Australian and international markets. Here the estimated
coef?cients in the model for conventional investment are insigni?cantly different
from zero, indicating that when international stock markets decline, conventional
investment returns in Australia follow those of international conventional investments
downward.
5. Research limitations
The model that we have estimated in this study is not without limitations. The
methodology assumes that alpha and beta in the market model are constant. This is the
subject of ongoing research. Second, it categorises the state of the market into “normal”
economic conditions and downturns using dummy variables. More sophisticated
techniques could be used in future research.
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The fact that we have found statistically signi?cant differences in the betas between
periods of increasing and decreasing returns suggests that the betas are in fact
time-varying to some extent. In the present case, this is not in itself particularly
important – “average” betas (which are in effect what we have estimated here) have
been shown to vary very little from the averages of time-varying betas estimated using
more complex methods (Brooks et al., 1998).
Consequently, we believe that the simplicity of the model presented here has much
to recommend it in terms of accessibility. Moreover, given that it is not our intention to
obtain the best possible estimates of beta or to forecast returns, but to simply establish
if they are affected by the direction of the market, it is unlikely that a more complex
method of analysis would produce results that differ in any relevant way from those
presented here.
Nevertheless, it would be possible to investigate the causes of the observed changes
in beta in these markets using more complex methods. Recall that beta is de?ned, as in
equation (2) as the ratio of the covariance between the industry portfolio and the
market and the variance of the market:
b
i
¼
covðR
i
; R
m
Þ
varðR
m
Þ
ð5Þ
The model used here estimates the differences in the magnitude in this ratio when the
market is rising and falling. These differences can be caused by changes in the
covariance between the industry and the market, the variance of the market, or both.
These effects could be distinguished using a multivariate version of the GARCHmodel,
which allows the variance of the two series and the covariance between them to be
estimated at every point of time. This would then allow the calculation of time-varying
betas. The important point is that this more complex model would only serve to
explain the source of the difference in beta that we have observed, in terms of the
impact of good and bad news upon the covariances and variances, rather than upon the
ratio of the two. While this is not without interest, it would add little to the topic at
hand and we leave it for future research.
6. Practical implications
Our ?ndings have important implications for fund managers. First, for an Australian
fund manager whose trust deed or taxation status limits it to investments
within Australia, SRIs are normally riskier than conventional investments. During
an economic downturn when conventional equity investment returns decline, SRI
returns also decline (though interestingly, not by as much, which is consistent to
some extent with Benson and Humphrey (2007) and Bollen (2007)). Second, for a fund
manager – whether based in Australia or overseas – who is able to invest globally, SRIs
are normally as riskyas conventional investments, but become riskier thanconventional
investments when the world enters an economic downturn such as the GFC. Having said
this, if the fund wishes to remain long in SRIs during an economic downturn, SRIs in
Australia are generally safer than SRIs in other countries.
Furthermore, these ?ndings have compelling legal implications for conventional
fund managers and trustees. On an economic viewof trust law, a traditional investment
trustee has a duty to maximize risk-adjusted returns (Boasson et al., 2004, p. 56;
Martin, 2009, pp. 1, 2 and 18). Moreover, a fund trustee risks breaching its ?duciary
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duties if it sacri?ces adequate risk-adjusted returns in the pursuit of non-?nancial goals
such as SRI (Ali and Gold, 2002, pp. 18, 31)[1]. Also, there is evidence that many fund
trustees and managers do fear the risk of lawsuits for breaches of their ?duciary or
statutory duties if they invest in SRIs (Lane, 2006, pp. 33-4), or at the least, believe that
there is less risk of lawsuits if they invest in conventional (non-SRI) investments (Dobris,
2008, p. 761). Williams and Conley (2005a, p. 546n) even found that 55 percent of the
largest mutual funds in the US vote against all social and environmental proposals;
15 percent vote against nearly all such proposals; and 30 percent abstain from voting.
Nor are the fundamental problems solved by using a combination of traditional Master
Trusts and SRI sub-trusts since, unless the objects of a traditional Master Trust have
been varied in accordance with a power of variation in the trust deed, the Master Trust is
likely to be infected by the breach of duty.
Much, of course, depends on the objectives set out in the relevant trust deed (Finn,
1989)[2]. Other things being equal, existing traditional (non-SRI) trusts cannot simply
invest in SRIs if their deeds do not allow this. If they purport to do so, traditional fund
trustees and managers do risk breaching their ?duciary or statutory duties not to
unconscionably exercise a power for a purpose not justi?ed by the trust deed[3]; or a
statute (e.g. invest in SRIs if the ability to do so is not permitted by the trust deed or
legislation).
Such an exercise is likely to constitute a fraud on a power; not acting in the best
interests of all bene?ciaries, and perhaps pursuing its own interests[4]; not acting in
good faith, and possibly misusing property held in a ?duciary capacity or engaging in
con?icts of duty and interest[5]; and/or failing to treat bene?ciaries of different classes
fairly – for example, by advantaging some bene?ciaries or bene?ciary classes at the
expense of others (Finn, 1977, Chapter 10).
Unless the trust deed contains an explicit power of variation (and many older trust
deeds do not), such investment in SRIs could trigger a resettlement of the trust, with a
concomitant substantial capital gains tax bill if the trust was settled after September
1985 (Australian Taxation Of?ce, 1999). While this would not occur if the trust is a
tax-exempt charitable purpose trust, most investment trusts in this context are not. It is
this prospective pecuniary cost which is far more likely to precipitate a lawsuit than
any umbrage about a breach of ?duciary responsibilities per se.
This situation is likely to continue unless perhaps relevant legislation is reformed to
enhance the attractiveness of SRI as an investment. Whether this is viewed as desirable
ultimately depends on the type of society we want – that is, on societal values and the
political will for legislative reform. Possible reforms could include:
.
allowing conventional fund managers and trustees to invest in SRI without
triggering resettlement of their trusts, together with the resultant massive capital
gains tax bills this would produce;
.
tax concessions for SRI (e.g. a 150 percent tax deduction or investment allowance
for SRI; and
.
allowing SRI sub-funds to obtain deductible gift recipient status from the
Australian Tax Of?ce and other taxation authorities.
A detailed analysis of such proposals must, however, be the subject of future research.
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Notes
1. See also, for example, the principles laid down in Vatcher v. Paull [1915] AC 372, 378; Chan v.
Zacharia [1984] 154 CLR 178, 198 per Deane J; Keech v. Sandford (1726) Cas. T K 61; and
Chief Commissioner of Stamp Duties (NSW) v. Buckle and Others (1998) 98 ATC 4097.
2. See also Hospital Products Ltd v. United States Surgical Corp (1984) 156 CLR 41,
68 per Gibbs CJ.
3. Vatcher v. Paull [1915] AC 372, 378.
4. Chan v. Zacharia [1984], 154 CLR 178, 198 per Deane J.
5. Keech v. Sandford [1726] Cas. T K 61.
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Keech v. Sandford (1726), Cas. T K 61.
Nestle v. Westminster [1993] 1 WLR 1260.
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Corresponding author
Eduardo Roca can be contacted at: e.roca@grif?th.edu.au
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