Loyalty and Socially Responsible Investing

In 1990, the investment firm of Kinder, Lydenberg, Domini and Company created an index for mutual funds that gave new meaning to the word exclusive. Instead of focusing on a particular niche or geographic area, the Domini Social Index weeded out firms according to their behavior. Excluded from the index were companies that derived two percent or more of their sales from military weapons systems or derived any revenues from gambling products or the manufacture of alcohol or tobacco products.

The Domini Index also subjected candidate companies to qualitative screens for investment. CSX Corporation, for example, was dropped from the Index in 1998 because of its poor environmental and safety record. In the following year, Compuware Corporation was added because of its successful diversity program and good employee relations.

In the decade that followed the debut of Domini, assets invested in all socially screened portfolios grew to exceed $2 trillion. Of that amount, $136 billion were invested in mutual funds, reflecting increased awareness of social responsibility and corporate ethics in the investment community.

“Socially responsible (SR) investing,” notes Nick Bollen, Associate Professor of Management, “integrates personal values and societal concerns with investment decisions.” Research into SR investing has focused on how SR funds perform compare to conventional funds. But no one had examined the dynamics of investor cash flows into SR funds. For these investors, did bottom-line performance ultimately trump loyalty to corporate social responsibility?


For fund managers, who are always seeking sources of stable investment — and for whom volatility with inflows and outflows from funds can create substantial burdens — these questions are important. Bollen determined to find the answers.

Bollen’s paper, “Mutual Fund Attributes and Investor Behavior,” which examined the relationship between fund performance and cash flows over a decade, provides some intriguing new insights into this segment of the mutual fund marketplace.

For example, Bollen found, just as many had long assumed (and anecdotal evidence supported) investors were more likely to be loyal to socially responsible funds than to conventional ones. From month to month, cash flows to and from SR funds were less volatile than those of other funds. Investors were more likely to allow their investments to remain in SR funds even if the funds’ performance lagged behind that of their conventional counterparts. At the same time, investors were less likely to contribute additional investments into these funds if their performance lagged behind.

“The results,” writes Bollen, “indicate that investors derive utility from the socially responsible attribute…. Mutual fund companies can expect SR investors to be more loyal than investors in ordinary funds.”

Published Feb 5, 2007 in Vanderbilt Business Intelligence
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Copyright 2007 Vanderbilt Owen Graduate School of Management