Why do investors hold socially responsible mutual
funds?
Citation for published version (APA):
Riedl, A., & Smeets, P. (2017). Why do investors hold socially responsible mutual funds? Journal of
Finance, 72(6), 2505-2550. https://doi.org/10.1111/jofi.12547
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Published: 01/12/2017
DOI:
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THE JOURNAL OF FINANCE
•
VOL. LXXII, NO. 6
•
DECEMBER 2017
Why Do Investors Hold Socially Responsible
Mutual Funds?
ARNO RIEDL and PAUL SMEETS
∗
ABSTRACT
To understand why investors hold socially responsible mutual funds, we link ad-
ministrative data to survey responses and behavior in incentivized experiments. We
find that both social preferences and social signaling explain socially responsible in-
vestment (SRI) decisions. Financial motives play less of a role. Socially responsible
investors in our sample expect to earn lower returns on SRI funds than on con-
ventional funds and pay higher management fees. This suggests that investors are
willing to forgo financial performance in order to invest in accordance with their social
preferences.
SOCIALLY RESPONSIBLE INVESTMENTS (SRIs) are increasing in economic and fi-
nancial importance, as testified by their growing volume in Europe and the
United States (EUROSIF (2014), Social Investment Forum (SIF, 2014)). In
the United States, for instance, already one in nine dollars of professionally
managed assets are involved in SRI. These investments are a puzzle in fi-
nance, however, because they deviate from the market by excluding potentially
high-return “sin” companies from their portfolio or by focusing on companies
∗
Arno Riedl is with CESifo, IZA, Netspar, and the Department of Economics (AE1), School of
Business and Economics, Maastricht University. Paul Smeets is with the Department of Finance
and European Centre for Corporate Engagement (ECCE), School of Business and Economics, Maas-
tricht University. A former version of this paper was previously circulated under the title “Social
Preferences and Portfolio Choice.” We are grateful to Robeco for providing us with the administra-
tive data used in this paper and we particularly thank Peter Jurriaans, Catrien Kleinheerenbrink,
Manon Middelink, and Jorg Sunderman. This paper benefited especially from the comments and
suggestions of two anonymous referees, an anonymous Associate Editor, and the Editor (Kenneth
J. Singleton), as well as of Clifton Green, Chris Parsons, and Nicolas Salamanca. We are also grate-
ful to the valuable comments of Rob Bauer, John Beshears, Thomas Dohmen, Piet Eichholtz, Uri
Gneezy, Arvid Hoffmann, Christine Kaufmann, Stephan Meier, Thomas Post, Sebastien Pouget,
Walid Saffar, Tao Shu, Avi Wohl, and Leonard Wolk. We thank seminar and conference partici-
pants at the EFA 2013, Society for Experimental Finance 2014 conference, Science of Philanthropy
Initiative 2015, Toulouse School of Economics, UC San Diego Rady School of Management, UC San
Diego Applied Microeconomics, and University of Heidelberg. We also thank Philip Abele, Oana
Floroiu, John Kramer, Mohammedreza Maghroor, Tobias Ruof, Simone Vermeend, and Thorsten
Voss for their help as research assistants. Paul Smeets received financial support from MISTRA
and the European Centre for Corporate Engagement (ECCE). Part of this paper was written while
Paul Smeets was visiting the Rady School of Management (UC San Diego). Paul Smeets is sup-
ported by a VENI grant from the Netherlands Organisation for Scientific Research (NWO) under
grant number 016.Veni.175.019. The authors declare no conflict of interest.
DOI: 10.1111/jofi.12547
2505
2506 The Journal of Finance
R
that have high scores with respect to environment, human rights, employee
relations, and so forth (SIF (2014)).
Why do investors hold socially responsible mutual funds? While it is tempting
to conclude that strong prosocial preferences drive this decision, other motives
are also possible. On the financial side, investors may have optimistic risk-
return expectations for SRI or a desire to diversify their portfolio risk. Another
possible motive could be that investors hold SRI to boost their social image or
reputation.
The theoretical and empirical evidence regarding these possible explana-
tions is inconclusive. With respect to social preferences, some theoretical mod-
els assume that investors may be willing to pay a premium to invest in so-
cially responsible companies (e.g., Heinkel, Kraus, and Zechner (2001), Gollier
and Pouget (2014)). Other recent theoretical contributions imply that holdings
of SRI funds do not necessarily reflect social preferences (Dufwenberg et al.
(2011), Sobel (2015)). Direct empirical evidence on the role of social preferences
in SRI is missing.
A few empirical studies show that SRI equity may perform financially better
(or not worse) than conventional investments.
1
Other studies, however, find
that investing in a socially responsible manner is financially costly.
2
Thus, it is
impossible to deduce from prior literature whether investors hold SRI equity
funds because they expect these funds to outperform conventional equity funds;
there exists little direct empirical evidence on whether investors expect SRI
funds to perform better than conventional funds (Nilsson (2008), Bauer and
Smeets (2015)).
Regarding reputation motives, several theoretical and experimental papers
emphasize the importance of creating a positive social image via social signal-
ing.
3
Investors could achieve such a positive image, for instance, by talking to
others about their SRI. As far as we know, however, no study explores social
reputation as a possible motive for SRI.
In this paper, we shed light on why investors hold socially responsible mu-
tual funds by combining administrative investor data, behavior in incentivized
experiments, and survey data. Specifically, we first obtain administrative data
from a large mutual fund provider that offers a wide variety of socially respon-
sible and conventional mutual funds. Individual investors buy and sell their
funds directly online without the interference of an intermediary. We then
1
See, for instance, Bauer, Koedijk, and Otten (2005), Derwall et al. (2005), Kempf and Osthoff
(2007), and Edmans (2011). Moreover, Karpoff, Lott, and Wehrly (2005) find that the losses of
firms that violate environmental regulations are equal to the legislation costs but that firms face
no additional costs due to reputation loss.
2
For instance, Fabozzi, Ma, and Oliphant (2008) and Hong and Kacperczyk (2009) find that
divesting from sin industries that involve weapons, tobacco, alcohol, or gambling is costly because
these companies tend to perform better than “nonsin” companies. Moreover, Kr
¨
uger (2015)finds
that stock prices sometimes react negatively to positive corporate social responsibility (CSR) news.
3
Theoretical contributions include Glazer and Konrad (1996), B
´
enabou and Tirole (2006), and
Ellingsen and Johannesson (2008). Empirical evidence is provided by Ariely, Bracha, and Meier
(2009), Fehrler and Przepiorka (2013), and Cappelen et al. (2017).
Why Do Investors Hold Socially Responsible Mutual Funds? 2507
merge these data with results from a survey and incentivized experiments
that we conducted using a large group of individual investors. We thus create
a unique data set that links the administrative data of conventional and so-
cially responsible investors to their behavior in controlled experiments and to
answers in a comprehensive survey.
To investigate the potential effects of social preferences on portfolio choice,
it is necessary to have a clean and independent measure of such preferences.
This measure should ideally be unaffected by strategic reputation considera-
tions (Kreps et al. (1982)) or social image concerns (Ellingsen and Johannesson
(2008)). To obtain such a measure, we let investors participate in a controlled
and anonymous one-shot trust game experiment (Berg, Dickhaut, and McCabe
(1995)). The trust game is a two-player sequential move game where the first
mover can transfer money to the second mover. The transferred amount is
tripled by the experimenter. The second mover can send back to the first mover
all, parts, or none of the money received. The behavior of the first mover mainly
captures trust, which is why the game is called a trust game. However, we want
to capture social preferences rather than trust. We therefore use the behavior
of investors in the role of second movers to measure intrinsic social preferences
(Karlan (2005), Falk, Meier, and Zehnder (2013)). A second mover who behaves
like the prototypical homo economicus should not send back any money. The
more an investor in the role of second mover returns, the stronger are the
investor’s i ntrinsic social preferences.
We find that intrinsic social preferences play an important role in deter-
mining SRI. An investor who equally shares the money in the experiment is
14 percentage points more likely to hold an SRI equity fund compared to a self-
ish investor who keeps all the money. This effect is economically substantial as
only 16% of our total sample holds an SRI equity fund. We also find that social
signaling motivates investors’ SRI equity holdings; investors who talk more
often about their investments are more likely to invest in a socially responsible
way. Moreover, socially responsible investors donate about 41% more to charity
than conventional investors, implying that SRI is not a substitute for charity
donations.
Financial motives also play a role in whether investors hold SRI. On the one
hand, we find that investors are willing to pay significantly higher management
fees on SRI funds than on conventional funds and a majority of investors expect
SRI funds to underperform relative to conventional funds. On the other hand,
we find that investors who expect SRI equity funds to underperform relative
to conventional equity funds are less likely to invest i n a socially responsible
manner. Hence, our evidence indicates that some investors are willing to forgo
financial performance in order to invest in mutual funds that are in concor-
dance with their social preferences, but at the margin pessimistic performance
expectations reduce the likelihood of investing in a socially responsible way.
Investors who expect SRI equity funds to perform financially better than con-
ventional equity funds are not more likely to hold such funds.
Risk perceptions are unrelated to holdings of SRI funds. However, investors
who generally hold funds longer are more likely to invest in SRI equity funds,
2508 The Journal of Finance
R
which indicates that socially responsible investors have a longer investment
horizon. We also find that investors with larger portfolios are more likely to
hold SRI, perhaps for risk diversification reasons.
4
Individual socioeconomic
characteristics only play a marginal role in determining whether investors
hold SRI equity funds.
Overall, we identify a number of factors that influence individuals’ decisions
to invest in a socially responsible manner. Our most robust and strongest result
is that intrinsic social preferences play a dominant role, even when controlling
for risk preferences, trading activity, realized Sharpe ratios, and other investor
characteristics.
Interestingly, when we look only at investors who hold an SRI equity fund in
their portfolio, we do not find a significant relation between social preferences
and the percentage invested in SRI equity funds. This suggests that strong so-
cial preferences are needed to buy an SRI fund in the first place, but that they
are less important for choosing the fraction of the portfolio to allocate to SRI
funds once this first hurdle has been overcome. However, in line with the social
signaling hypothesis, we find that investors with weak social preferences who
strongly signal their investment behavior hold significantly smaller shares in
SRI. This suggests that relatively selfish investors who hold SRI for signal-
ing reasons minimize the percentage of SRI they hold. In addition, we find
that financial motives affect the fraction invested in SRI funds. In particular,
investors with a larger portfolio invest a smaller fraction in SRI funds, most
likely to diversify their portfolio.
Our empirical results are related to several theoretical models. In their sem-
inal work, Heinkel, Kraus, and Zechner (2001) develop a model in which some
investors refrain from investing in nonresponsible companies. These investors
drive up the price and lower the expected returns of socially responsible com-
panies, because the risk of nonresponsible firms is borne by f ewer investors.
Similarly, Fama and French (2007) show that taste for assets can influence
stock prices. Gollier and Pouget (2014) develop a model in which investors can
improve the social responsibility of firms by excluding nonresponsible com-
panies from their portfolio or by activism against nonresponsible firms.
5
Our
paper provides empirical support for a key assumption of these models: social
preferences are indeed an important determinant of investment decisions.
Some previous empirical studies show that socially responsible investors may
behave differently from conventional investors. Bollen (2007) and Renneboog,
Ter Horst, and Zhang (2011) find that, ex post, investors are more likely to hold
on to badly performing SRI funds than to poorly performing conventional funds.
Hong and Kostovetsky (2012) report that, in comparison to Republican fund
4
An anonymous referee pointed out that wealthy investors might hold SRI for social capital
reasons. We cannot exclude this possibility as our data do not lend themselves to investigating this
hypothesis.
5
De Bettignies and Robinson (2015) develop a model that examines whether CSR is beneficial
for society. Baron (2007) models socially responsible firm behavior as donations. He shows that the
cost of social responsibility is borne by the social entrepreneur when going public rather than by
the shareholder as long as CSR is anticipated by shareholders.
