Does Socially Responsible Investing Pay in Developing Countries? A Comparative Study Across Select Developed and Developing Markets

Abstract

Socially responsible investing (SRI) is the catalyst in aligning financial growth with sustainable development. The current study is an attempt to investigate the viability of responsible investment across major developing and developed countries of the world. The authors evaluate and compare the performance of socially responsible indices, against their general and conventional counterparts, in select developing and developed countries through market conditions of bull and bear over a 12-year window. Descriptive statistics and risk-adjusted-performance evaluation methods of performance evaluation reveal socially responsible investing to be non-penalizing in developing countries. Premium rewards earned by SRI help the responsibility indices in emerging countries secure topmost ranks, using Fama’s decomposition model. While no significance in difference of performance is found among the indices in overall period, the study finds that the SRI strategy in emerging economies can provide investors with a safe investment vehicle during adversity. Thus, SRI can provide diversification benefit to the international investor seeking country effect, social impact as well as financial reward through responsible investing. The study on SRI index evaluation implies useful insights for achieving global sustainability goals through the use of financial tools to every market participant, especially in the era of globalization.

Keywords

Bull–bear phase emerging nations Fama’s decomposition performance evaluation socially responsible investing

Introduction

Socially responsible investing (SRI) is an approach to financial decision-making that avoids investments into organizations that cause a ‘social harm or loss’. It is a holistic investment strategy and a sustainable development instrument to punish socially irresponsible corporations by screening them out, while raising stakes in socially aligned firms. This strategy of financing is especially relevant in current times when countries facing limited and non-renewable resources have resorted to the pursuit of Sustainable Development Goals. For aligning the financial markets with these goals, environmental, social and governance (ESG) integration has been an effective tool for business model evaluation as well as investing for a sustainable growth, rather than short-term profitability.

In the last two decades, with rising relevance of sustainable development along with global integration, greater efforts for incorporating the social responsibility concerns in financial systems were made. The earliest SRI fund, the PAX World Fund, was introduced in the USA in 1971, followed by the launch of the first socially responsible index (Domini 400 Social Index) in 1990. Meanwhile, investors across major developed countries, too, accelerated their responsible efforts by participating in United Nations’ Principles for Responsible Investment and incorporating them in their investments. Presently, all the major economies of the USA, Australia, the UK, Japan and Europe witness market players—such as retail and institutional investors, enterprises and governments—being linked through an extensive network of conventions, committees and sustainability forums aimed at pursuit of the common sustainability goal (OECD, 2019). Thus, the developed nations across the world have been instrumental in the expansive multi-fold growth (Fowler & Hope, 2007).

In the case of developing countries, SRI is still at a budding stage and has a niche market (Tripathi & Kaur, 2020b). Given the massive growth potential, manpower, thriving financial markets and a high saving rate, the emerging countries of the world hold huge potential for the expansion of the phenomenon. The potential is backed by relevance of a sustainable growth in an emerging economy, where the benefits of SRI could trickle down different sects of the society, while curbing an inequality of income, resources and opportunities (Vives & Wadhwa, 2012).

Rising relevance in last two decades has resulted in attracting greater interests of the institutional investor, retail investor as well as researchers alike, especially among the developed economies. Meanwhile, factors such as non-stringent regulatory norms, inconsistent disclosure mechanism, lack of intent of the corporations, apprehension among investors and opportunist orientation of fund managers have crippled the penetration of SRI in developing countries. Insufficient and inconsistent ESG disclosure data of corporations have further restricted many empirical studies of the performance of SRI in these countries. Therefore, a greater focus on performance evaluation of SRI, especially in emerging countries, is required.

An extensive global integration has resulted in intertwining of financial, environmental and social systems across countries as well as resulting externalities. The world economy is confronted with problems of population growth, climate change, terrorism and pollution requiring active participation from all sects of the world. Unequal distribution of resources calls for coordinated actions in the financial markets, too, by the developed and developing economies of the world for a sustainable growth. As psychological, cultural and behavioural differences prevail among countries, extending results and ideas of Western/OECD/developed countries over developing markets can give rise to discrepant results, signifying the importance of evaluation of social responsibility vehicles in emerging countries. A cross-country analysis also highlights the contrast between the performance of social responsibility vehicles encouraging greater interest of asset managers, domestic as well as international investor while also addressing inhibitions related to responsible investing. Therefore, this study aims at evaluating the performance of social responsibility efforts of the respective markets and presents a cross-country analysis for financial decision-making.

In line with the requirement of more research on SRI in developing economies, the current study adds to the existing literature in a number of ways. The performance of socially responsible indices of the select developing and developed countries is evaluated using various traditional and risk-adjusted-performance measures. The study is unique in its approach, and the evaluation is carried out using index data. Index data are considered an improvement over portfolio data as indices are immune to biases associated with funds (such as management quality or operating costs) and isolate the impact of the SRI factor on performance (Belghitar et al., 2014; Sauer, 1997; Schröder, 2007; Statman, 2000, 2006). The study tests the impact of market conditions on SRI performance by contrasting emerging and developed country indices data in the bull and bear market. The SRI index performance is studied in contrast with the conventional, as well as market index peers in developing and developed countries of the USA, the UK, India and China.

The study is relevant to contemporary literature for bringing out the difference in performance of screened and unscreened strategies over select countries holding international power, while also exhibiting respective developed and developing market traits. As countries across the world bear the onus to work in integration for achieving sustainability, the select countries have been chosen to reflect initiations in sustainable practices. Among the select developed countries, the USA is considered the economic superpower for holding the world’s largest economy consistently since the country of the UK is empowered by highly developed and penetrated financial markets. The economies of India and China are the two fastest-growing developing countries in Asia and hold prime importance in emerging countries association of Brazil, Russia, India, China and South Africa (BRICS). Paced by exponential growth over the two decades and following the US economy closely on heels is the Chinese economy holding $27.31 trillion of the world gross domestic product. Its neighbouring country of India, also known as the fastest-growing ‘Asiatic giant’, is backed by the huge skilled manpower, expanding demand and economic growth rates. Incorporating the select countries in the sample, following objectives have been studied in the paper:

To examine the performance of socially responsible indices, conventional indices and market indices of the select developing and developed countries.

To compare the performance of socially responsible indices using various risk-adjusted measures during market conditions of bull and bear periods in the select developing and developed countries.

To study the impact of market conditions of bull and bear on socially responsible indices and conventional indices of developing and developed countries.

The rest of the paper proceeds as follows. In the subsequent section, we review the existing literature on both developed and developing markets. The third section discusses the data and methodology, while the fourth section discusses the empirical findings. The fifth section discusses the various findings study and the sixth section summarizes the study. In the last section, Implications, the study defines the utility of the study to various stakeholders.

Literature Review

SRI Concept and Performance

SRI may be called as a follow-up to corporate social responsibility (CSR). In the early 20th century, few large businesses were the power centres of the society, engaging a large part of the population and impacting numerous stakeholders (Carroll, 2008). Wealth maximization was the only objective of the firms. With the development of human resource management theories, labour movements and launch of the milestone book by Howard R. Bowen, Social Responsibilities of the Businessman, set the momentum of CSR pacing during the mid-1950s. Social consciousness among the firms was acknowledged and rewarded by the investors with equal zeal who, in turn, raised stakes in companies functioning the responsible way. This was followed by studies exploring the costs and gains of investing responsibly. The implications of these studies and results of the extant literature on performance evaluation of SRI, relative to benchmarks, can be divided into three competing hypotheses (Hamilton et al., 1993; Statman, 2000).

The first hypothesis proposed is the ‘no difference’ hypothesis, wherein the SRI neither underperforms nor outperforms the market counterparts. Majority of the extant literature investigating the performance of SRI finds evidence supporting this hypothesis (Von Wallis & Klein, 2015). This can be attributed to the high sensitivity of the SRI to the market movements, resulting in an insignificant difference in the risk–return performance (Guerard, 1997; Plantinga et al., 2008). Studying the SRI portfolios against conventional benchmarks through different market conditions, Shunsuke et al. (2012) could not find significant difference in the performance of the two contrasting investment strategies. Luther et al. (1992), Bauer et al. (2004) and Schröder (2007) investigate the risk-adjusted performance of SRI unit trust, mutual funds as well as the index, respectively, against conventional/market benchmarks to conclude no significant difference in the performance of the two strategies.

The second hypothesis proposed by Hamilton et al. (1993) implies that SRI underperforms its conventional counterparts. This hypothesis builds on classic portfolio theory (Markowitz, 1952); it proposes that a screening of investment universe increases risk by reducing diversification benefits of the restricted volume of securities. Restricted diversification benefits, higher volatility of returns, incremental sensitivity to systematic risk, agency problems and increased information asymmetry are some causes of observed underperformance in the empirical studies. Adler and Kritzman (2008), Ortas et al. (2012) and Belghitar et al. (2014) found evidence supporting this hypothesis and conclude the underperformance as the ‘cost of screening out’ due to a smaller diversifiable universe left after a screening of ‘sin’ stocks. Even as scant literature is found reporting significant underperformance of SRI, there exist numerous studies finding mixed results through different economic and market conditions and across regions. The higher variability of returns of SRI funds/indices, than their conventional counterparts, was observed in developing countries stemming from higher information asymmetry, inconsistent ESG disclosures of firms or a lenient regulatory framework of institutions (Srinivasan, 2014; Tripathi & Bhandari, 2014; Ur Rehman et al., 2016). Meanwhile, better performance of SRI benchmarks was observed to be carrying higher risk relative to the market counterparts. This higher risk has been attributed to the systematic risk from the concentration of SRI in some and absence in other industries and sectors (Collison et al., 2008; Mill, 2006; Ortas et al., 2012; Ur Rehman et al., 2016). The performance of SRI is found to be varying across different market conditions, where the authors found responsible investing to be outperforming during the boom but underperforming the conventional portfolio during bear phases of the market (Hume & Larkin, 2008; Statman, 2006). Palma-Ruiz et al. (2020) found 12 out of IBEX-35 countries in the ESG activities, in form of donations amid the COVID-19 crisis, to be performing better than their counterparts who did not donate. The orientation of the retail investor in Spain was also observed to have grown pro-responsibility and incorporating ESG while investing. Soler-Domínguez & Matallín-Sáez (2016) establish a link between performance of funds and economic conditions and observe that socially irresponsible portfolio underperform responsibility portfolios during times of economic distress even as they outperform the latter in times of jubilant markets.

The third hypothesis is that the expected return of SRI is higher than that earned by the conventional benchmarks. This is due to the expectation of the higher cost of holding SRI investments. Further, conventional investors constantly underestimate the costs of externalities generated by such conventional/non-SRI companies while overestimating the costs of holding responsible companies relative to their benefits (Marsh, 2000). Sufficient literature exists indicating the SRI mutual fund portfolios as well as indices beating the markets during identified economic and market conditions, bolstering the assumption of ‘doing well while doing good’ (Collison et al., 2008; Curto & Vital, 2014; Hill et al., 2007; Hume & Larkin, 2008). The expected returns of SR stocks have been documented to be greater than those of conventional stocks, especially during the crisis period, encouraging higher money flows in the relatively secure and reliable investment funds (Parida & Wang, 2018; Paul, 2017; Nofsinger & Varma, 2014). The cost of externalities, in the case of SRI, is reduced as screening out of ‘socially irresponsible’ or ‘sin’ firms and investing in higher ESG rated firms curbs litigation and uncertainty costs and raises the credibility of fund management (Konar & Cohen, 2001; Renneboog et al., 2008). Paul (2017) tried to establish a link between corporate social performance and financial performance and found that SRI served as boon during times of contraction and added value more than it did during economic expansion. Notably, employment of additional screens was linked to greater excess returns (Guerard, 1997) as well as a better financial performance of the fund engaging certain numbers of screens, derived from a ‘U-shaped’ curve (Barnett & Salomon, 2006).

Thus, a review of performance of socially responsible investing reveals a mix of results. The study, thus, aims to evaluate the performance based on risk-adjusted measures as well as non-metric measures such as Fama decomposition ranking across different market conditions.

SRI in Developing and Developed Countries

It is observed that SRI differed extensively, in practice as well as in principle, across different countries (Louche & Lydenberg, 2006; Arjaliès, 2010). Literature empirically proves the impact of investor values and ethics, a result of the cultural environment, on the performance of SRI funds (López-Arceiz et al., 2018; Ortas et al., 2012). Sandberg et al. (2009) reinstate the importance of regional context in the study of SRI by observing that cultural and country differences might be one explanation for heterogeneity in the performance of SRI. Badía et al. (2020) reveal that the financial impact of socially responsible investing is geographically dependent, varies over time and relies on the screening dimension by studying socially responsible stock portfolios in four regions of North America, Europe, Japan and Asia Pacific. Louche and Lydenberg (2006) compare SRI in the European Union and the USA and found that although the concepts are the same across regions, the implementation differs. The level of economic development of a country, too, impacts the strategy of a firm and, in turn, affects the performance, development and penetration of SRI in an economy (Porter & Van der Linde, 1995). The development of a country is determined by numerous factors including per capita gross domestic product, the level of industrialization, the general standard of living and the amount of technological infrastructure.

Researchers have found enormous opportunities of investment in Asian stock markets, given the economic stability through crisis periods and expansion of stock markets over last decades (Kumar et al., 2017). Studying volatility through GARCH models in emerging markets over a period of 10 years, Mishra (2012) found greater market volatility in emerging countries of BRIC, indicating contagion from developed market crises. Limited studies exist studying responsible investing in emerging economies and presenting a cross-country comparison of the socially responsible investment performance, of which fewer reflect on developing and developed country contrasts on SRI performance in the respective country. Insufficiency/inconsistency of ESG disclosures, lower penetration of capital and financial markets, the prevalence of rubric vertical collectivism and lack of awareness are some of the factors hindering the growth in the field abstaining research in emerging economies. Hill et al. (2007) were among the first few to carry out a cross-regional/continental comparison of the SRI portfolios against the market portfolios, they discovered the superior performance of not just American/European SRI, but also Asian SRI Portfolios against the conventional benchmarks in the long run. The superior performance of the SRI is accompanied by higher volatility of returns. The higher relative levels of volatility in Asian indices as well as short-term underperformance could be traced to inherent limitations in market development and information asymmetry along with pyramid corporate hierarchy and weak regulatory frameworks as commonly observed in emerging markets (Hill et al., 2007; Tripathi & Kaur, 2020a; Ur Rehman et al., 2016; Weber, 2014). Anwer et al. (2019) find that screened stock indices in emerging markets are impacted by the global monetary environment. In his study, Travers (1997) focuses on SRI outside the USA and observed 23 selected SRI mutual funds from Europe, Australasia and Asia outperforming their benchmark. Chapple and Moon (2005) evaluated SRI in seven major economies of Asia—India, Indonesia, Malaysia, the Philippines, South Korea, Singapore and Thailand—and found that social responsibility varies between these countries, which might be explained by national factors as well as their sensitivity to the globalization. Meanwhile, Rana et al. (2020) reinforce the linkage of emerging economies to the developed countries due to greater internationalization of enterprises and their complementary marketing systems, where innovations in these economies are driven, not only by their own firms but also by the subsidiaries of advanced country MNEs. Thus, it becomes imperative to study SRI in emerging markets, relative to their developed counterparts.

Thus, a review of literature exposed gaps in the field of research in SRI in emerging countries. The review exposes further scope for exploring the concept in developing countries relative to developed countries as opportunities for the development of SRI are wide and growing (Williams, 2010). Unfortunately, to the authors’ best knowledge, no research contribution investigating and comparing the performance of SRI in developed and developing countries has been made. Thus, the study focuses on studying the performance of major socially responsible, conventional as well as market indices in the select developing countries relative to developed countries.

Research Methodology

The current study aims to examine the performance of socially responsible investing in developed and developing economies and present a comparative evaluation between different parameters for the period extending from 1 September 2007 to 31 March 2020. The study period has been selected to include historical data of the ESG indices since their inception in September 2007. The study period is limited to a 12-year window due to the non-availability of consistent and sufficient historical data in the case of the developing countries. The study period is further segregated into bull and bear markets to study the impact of market conditions on performance of SRI in select countries. To identify the market break periods, we use the four Morgan Stanley Capital International Investable Market Indices (MSCI IMI) benchmark indices for calculating the change of points. A bull (bear) market is a time period during which the market increases (declines) by at least 10% from its most recent low (high) (Hanna et al., 2020; Lockwood & McInish, 1990).

For the study, closing monthly index values in dollar currency terms of the select indices were taken from the MSCI website (www.msci.com). The data set of indices used in the study is accessed from the group of indices provided by the American Finance company MSCI. As comparable indices are subjected to a uniform base and methodology, the SR, conventional and benchmark indices from the same index provider render objectivity to our study.

The thematic series of MSCI ESG Leaders Index has been used as a proxy for socially responsible investing in the selected countries for studies. MSCI ESG Leaders Index Series is based on the best-in-class screening approach and includes large and medium market capitalization–weighted companies. Social responsibility and investing standards and guidelines, drawn from major international organizations of United Nations, International Labour Organization, and United Nations Global Compact, are taken as yardsticks to further screen out corporations associated with any ESG, ethical or sustainability concern. For the conventional style of investing, the specific MSCI Country index has been taken as proxy, representing about 85% of the free float–adjusted market capitalization of large- and mid-cap companies in the respective country. The broad market–specific MSCI IMIs have been used as a proxy benchmark index for each of the select developing and developed countries. The MSCI Country IMIs are a series of a data set representing the entire broad market with approximately 99% coverage of the large, medium and small market capitalization firms. These indices have an exhaustive coverage, which is in line with the Global Industry Classification Standard and aligns with index house requirements of non-overlapping size, style segmentation and minimum free float requirements. Relevant constituent sector weights of the select indices can be found in Table 1 (MSCI ESG Leaders), Table 2 (MSCI Country) and Table 3 (MSCI Investable Market).

Table 1.

Number of Constituents and Sector Weights of MSCI ESG Leaders Index of Select Countries

Index Series	Number of Constituents	Sectors Representing More Than 10% of Index Weights
MSCI US ESG Leaders	312	Information Technology (25), healthcare (14), financials (12), communication services (11)
MSCI UK ESG Leaders	49	Financials (20), FMCG (20), energy (14), healthcare (15), industrial (13)
MSCI India ESG Leaders	36	Information technology (26), energy (20), financials (19), FMCG (13)
MSCI China ESG Leaders	135	FMCG (40), communication services (29), financials (11)

Source: MSCI ESG Leaders Factsheet, www.msci.com.

Note: Numbers in parentheses represent sector weights constituting the index in percentage terms.

Table 2.

Number of Constituents and Sector Weights of MSCI Country Index of Select Countries

Index Series	Number of Constituents	Sectors Representing More Than 10% of Index Weights
MSCI US Index	637	Information technology (24), healthcare (14), financials (13), communication services (11), FMCG (10)
MSCI UK Index	96	Energy (53), materials (20), financials (18)
MSCI India Index	84	Financials (25), information technology (18), energy (15), FMCG (13)
MSCI China Index	704	FMCG (28), communication services (22), financials (19)

Source: MSCI Country Index Factsheet, www.msci.com.

Note: Numbers in parentheses represent sector weights constituting the index in percentage terms

Table 3.

Number of Constituents and Sector Weights of MSCI IMI Index of Select Countries

Index Series	Number of Constituents	Sectors Representing More Than 10% of Index Weights
MSCI US IMI Index	2,399	Information technology (23), healthcare (14), financials (13), FMCG (11), communication services (10), industrials (10)
MSCI UK IMI Index	354	Energy (12), industrials (12), financials (20), FMCG (15), healthcare (11)
MSCI India IMI Index	334	Financials (29), information technology (14), energy (12), FMCG (10)
MSCI China IMI Index	2,879	FMCG (16), communication services (11), financials (21), industrials (11), information technology (10)

Source: MSCI IMI Index Factsheet, www.msci.com.

Note: Numbers in parentheses represent sector weights constituting the index in percentage terms.

For performance evaluation techniques, the study employs 91 days t-bills bond rate for the select sample countries, the data for which were derived from the Bloomberg website as the proxies for risk-free rates. Risk–Return analysis is carried out using the natural log of returns. The return so calculated at time t is Rt = ln (It/It − 1), where I1, I2, I3,…,It values are the monthly closing index prices. The paper starts by presenting descriptive statistics of all the SRI, conventional and market indices. Traditional mean-variance evaluative techniques, as well as higher moments of mean variance, are tested for the select indices.

Performance Evaluation of Sustainable Indices vis-à-vis Market Indices

Portfolio alphas and betas and various risk-adjusted measures of the financial performance are evaluated for all the indices.

Traditional measures of performance evaluation:

Simple percentage return and standard deviation:

\begin{matrix} S i m p l e % r e t u r n = P t - P t - 1 \\ P t - 1 \\ s \tan d a r d d e v i a t i o n = \sqrt \sum | x - μ | ² \\ N \end{matrix}

Beta: Beta calculates the sensitivity of portfolio return relative to the market return. The formula to calculate portfolio beta is as follows:

R p - R f = x + β (R_{M} \underline{-} R f) .

Systematic risk and unsystematic risk: Systematic risk accounts for volatility in returns due to broad macro factors affecting all securities. Unsystematic is that part of the risk that can be eliminated by diversification.

\begin{array}{l} S y s t e m a t i c r i s k = \sqrt y^{2} \times σ_{M}^{2}, \\ U n s y s t e m a t i c r i s k = \sqrt (σ_{P}^{2}) - (y^{2} \times σ_{M}^{2}) . \end{array}

Risk-adjusted methods of performance evaluation:

Sharpe ratio: This ratio standardizes the returns above the risk-free rate by the variability of return.

\begin{matrix} S h a r p e ’ s r a t i o = A R_{P} - R_{f} \\ σ_{P} \end{matrix}

Treynor’s ratio: Beta used in this ratio assumes a well-diversified portfolio and standardizes the return over risk-free rate dividing it by the volatility of return.

T r e y n o r ’ s r a t i o = \underline{A R_{P} - R_{f} β_{P}}

Jensen’s alpha: This measure is used to determine excess or abnormal return of security or portfolio above the projected expected return. The expected return is theoretical as it is calculated using a market model, usually CAPM. The results could be inferred to be positive where the portfolio with positive returns will have a positive alpha, and conversely, a negative alpha will indicate negative returns.

α = R_{M} - [R_{f} + (R_{M} - R_{f}) β_{P}] .

M² ratio: Comparison of portfolios with different levels of risk has been widely done across literature and previous studies. Our study will use Modigliani and Modigliani’s (1997) approach of using portfolios with the same level of risk to compare risk-adjusted performance.

M ² = R p * - R m,

where Rp* is the return of managed portfolio and Rm is the return of market portfolio.

Information ratio: This ratio measures a manager’s level of information along with his skill compared to public information. It is also defined as residual return divided by tracking error; the formula is given as follows:

I n f o r m a t i o n r a t i o = α p / σ e p,

where αp is Jensen’s alpha and σp is the unsystematic risk of portfolio.

Sortino ratio: A measure to evaluate performance by standardizing excess return over downside volatility only, the Sortino ratio is considered a variation of the Sharpe ratio. It is calculated as follows:

\begin{matrix} S o r t i n o r a t i o = A R_{P} - R_{f}, \\ σ_{D}, \end{matrix}

where σp is the standard deviation of downside risk.

Fama’s decomposition measure: Fama decomposed excess return into various factors including risk of the security and stock selection. These can further be decomposed into two components—risk premium (return for incurring risk) and stock selectivity (reward for stock selection). The risk premium is composed by the synthesis of systematic and unsystematic risk. The reward from only stock selectivity (R3) is the difference between the actual return and the sum of the other three components of the security’s return.

Reward for systematic risk, represented by R1 = β_P (R_M − R_f)

Reward for unsystematic risk, represented by R2 = [(σ_P / σ_M ) − βp] × ( R_M – R_f)

Fama’s net selectivity = R_P – [R_f + (σ_P / σ_M) × ( R_M – R_f)]

Total return on portfolio = Risk-free return (R_f) + Return for bearing systematic risk + Reward for incurring unsystematic risk + Reward for pure stock selectivity

Regression analysis using dummy variable: Single-factor dummy variable equation model is used to calculate risk-adjusted abnormal return performance of the SRI index relative to the benchmark in the select nations during bull–bear periods. We aggregate the various bull and bear periods over the study period from September 2007 to March 2020 and observe the abnormal returns (α) during these sub-periods. (β) values indicate the impact of market on the indices’ return. We estimate the following single-factor regression equation:

R_{P} - R_{f} = α_{0} + α_{1} D + β_{0} (R_{M} - R_{f}) + β_{1} D (R_{M} - R_{f}),

where R_P is the monthly log return of socially responsible index in select developing countries for the select period, R_f is the 91-day t-bills return of respective country and R_M represents monthly log return from the market index. We use dummy variable D to test the impact of economic conditions on alphas and betas of indices that takes value 0 for recession and 1 for the boom. In the equation, α0 is the excess return for the recessionary period in respect of R_P; α0 + α1 is the excess return for boom period in respect of R_P; β₀ is the slope of R_P in recessionary period in select countries; and β₀ + β₁ is the slope of R_P in boom period in select countries.

Empirical Results

Exploring the descriptive statistics of the select series during the selected period of study, we observe that mean returns earned fall behind the conventional as well as a market index in the developed countries of the USA and the UK, implying underperformance of the socially responsible indices in both the countries. A glance at Table 4 highlights the mean returns of socially responsible indices in the developing countries beating the conventional and market counterparts. This may be due to underestimation and resulting under-pricing of the SRI securities in the financial markets, leading to lower expected returns but a higher actual abnormal return earned by the responsible investors. Investigating the performance of select indices on higher moments of mean-variance analysis, we note that skewness of the responsibility indices remained lowest among the three selected indices for both the developed economies of the USA and the UK. According to Belghitar et al. (2014), investors also consider higher moments and prefer higher skewness, but lower kurtosis while investing. Studying the skewness measure of performance in the emerging nations of India and China, a notable difference is revealed. It is seen that the skewness of SR India proxy represented by the India ESG index beats the conventional and market counterparts by a large margin, while it is the Chinese market index that superiorly performs against the screened and unscreened market index of the country. Kurtosis measure of tail distribution renders interesting findings, where kurtosis is lowest for the market index in the USA as well as the UK, but remained lower for China relative to the peer developing country of India.

The return chart exhibited in Chart 1 highlights socially responsible indices of the developing countries toppling over the returns earned by their developed counterparts. It is also notable to find the series of developing countries have sharper troughs and peaks than the socially responsible indices of the USA and the UK.

Table 4.

Descriptive Statistics of Index Series Returns of the Select Developed and Developing Markets in the Overall Period (%)

	Developed			Nations			Developing			Nations
	US			UK			India			China
Stsatistics	US ESG Leaders	US Market Index	US IMI Index	UK ESG Leaders Index	UK Market Index	UK IMI Index	India ESG Leaders Index	India Market Index	India IMI Index	China ESG Leaders	China Market Index	China IMI Index
Mean	0.0044	0.0045	0.0078	−0.0031	−0.0027	−0.0021	0.0017	0.0007	0.0007	0.0033	−0.0005	−0.0003
Median	0.0108	0.0107	−0.0219	0.0012	0.0003	0.0022	0.0025	0.0022	0.0031	0.0135	0.0119	0.0115
Standard deviation	0.0444	0.0441	0.6992	0.0515	0.0526	0.0533	0.1190	0.0832	0.0858	0.0688	0.0758	0.0760
Sample variance	0.0020	0.0019	0.4889	0.0027	0.0028	0.0028	0.0142	0.0069	0.0074	0.0047	0.0057	0.0058
Kurtosis	2.9331	2.3678	5.7099	3.1495	1.6736	1.9724	5.5226	2.6350	3.0919	0.7044	1.3648	1.4471
Skewness	−0.9248	−0.9889	0.7720	−0.7622	−0.5505	−0.6198	0.5546	−0.2584	−0.2859	−0.4572	−0.7143	−0.7177

Source: Index data from Bloomberg.com and MSCI website.

Table 5 gives a summary of the performance of the select indices during the bull phase of the market. Observing traditional risk–return performance measures, we note the conventional index beating social responsibility as well as benchmark indices in terms of average returns and excess returns in the USA, while its contemporaries the UK as well as peers India and China have responsibility index beating the market counterparts. In terms of Sharpe’s measure of performance evaluation, it is seen that the socially responsible index successfully outperforms the conventional and market benchmarks in all the select developed and developing countries except the USA, where the conventional market index beats the screened and unscreened index. This implies a higher reward per unit of risk (standard deviation) undertaken by socially responsible investors in the developed country of the UK, as well as developing countries of India and China, a better reward being earned in the case of the former. The Sharpe ratio measures the returns earned per unit of risk earned. Using Treynor’s ratio to measure reward earned per unit of beta sensitivity risk, it is noted that the responsibility index continues to beat the counterparts in the UK, India and China, whereas it is toppled over by the market index in the USA. Notably, the responsibility index of China witnesses the highest Treynor’s ratio, implying the highest reward earned for undertaking market risk. While Sharpe had the least sensitivity to market and a systematic risk keeps lower for the responsibility index than conventional, it is the unsystematic risk that is significantly higher for the former. During the documented bull period, excess returns over the risk-free returns were highest for the conventional stock index in the developed country of the USA among its peer indices, whereas the SRI proxy index MSCI US ESG Leaders continued to underperform the market, causing a penalty to the responsible investor. Looking at the Jensen’s alpha measure in peer developed country of the UK, we find that it is the SRI index proxy that beats the conventional as well as benchmark market index. Responsibility index in emerging countries of India and China, too, follows the trends by earning abnormal returns during the bull period, thus implying no financial penalty for the pursuit of ethical goals. Notably, the socially responsible investor is rewarded the highest in terms of excess returns earned over risk-free returns, beating the conventional and broad market index over the documented bull period. Continuing the performance trends, the three countries of the UK, India and China toppled over the US SRI index in terms of M² measure, where the latter scored negative values. The measured M² performance evaluation technique implies that on creating portfolios with the same level of risk equivalent to the market portfolio, the SRI index generated positive values, which further produced returns higher than that of the general index and the market index. A higher information ratio in case of socially responsible indices in countries of the UK, India and China suggests incremental payoff relative to tracking error, arising from screening of investments over the returns of the benchmark. The modern risk-adjusted technique of the Sortino ratio measures the risk-adjusted return penalizing returns falling below the required rate of return. While a lower Sortino ratio measure implies lower returns earned per unit of the risk-free rate of return for the socially responsible investor in the USA, it is the SRI investor who reaps the benefit by earning an extra reward for investing in a socially conscious manner.

Chart 1.

Source: Index data from the MSCI website.

Table 5.

Performance Evaluation of SRI, Conventional and Market Benchmark Index Using Risk-Adjusted Measures in Select Developed and Developing Countries During the Bull Phase of the Market

Bull Market	Developed						Developing
Type	US			UK			India			China
Type	US ESG Leaders	US Market Index	US IMI Index	UK ESG Leaders Index	UK Market Index	UK IMI Index	India ESG Leaders Index	India Market Index	India IMI Index	China ESG Leaders	China Market Index	China IMI Index
Average returns	0.0565	0.0570	0.0565	0.0006	−0.0010	−0.0002	0.0098	0.0073	0.0078	0.0112	0.0084	0.0084
Excess returns	0.0003	0.0004	0.0003	0.0152	0.0136	0.0145	0.0043	0.0019	0.0024	0.0121	0.0093	0.0093
Standard deviation	0.6674	0.6587	0.6478	0.0482	0.0470	0.0464	0.0656	0.0672	0.0680	0.1307	0.1338	0.1339
Beta	0.9733	0.9875	1	0.9547	1.0000	1	0.9376	0.9843	1	0.9633	0.9983	1
Systematic risk	0.6210	0.6327	0.6478	0.0443	0.0469	0.0464	0.0638	0.0670	0.0680	0.1290	0.1337	0.1339
Unsystematic risk	0.1606	0.1189	0	0.0190	0.0029	0	0.0152	0.0061	0	0.0212	0.0044	0
Sharpe’s ratio	0.0005	0.0006	0.0005	0.3160	0.2905	0.3112	0.0663	0.0284	0.0348	0.0928	0.0696	0.0695
Treynor’s ratio	0.0003	0.0004	0.0003	0.0160	0.0135	0.0145	0.0046	0.0019	0.0024	0.0126	0.0093	0.0093
Jensen’s alpha	−0.0003	0.0001	0	0.0014	−0.0009	0	0.0021	−0.0004	0	0.0032	0.0000	0
M² ratio	0.0000	0.0001	–	0.0017	−0.0010	–	0.0021	−0.0004	–	0.0001	0.0000	–
Information ratio	−0.0019	0.0030	–	0.0760	−0.3240	–	0.1403	−0.0697	–	0.1493	0.0048	–
Sortino ratio	0.0005	0.0006	0.0005	0.5223	0.4677	0.4953	0.1420	0.0623	0.0774	0.0950	0.0729	0.0728
Modified Sharpe ratio	0.0005	0.0006	0.0005	0.3160	0.2905	0.3112	0.0663	0.0284	0.0348	0.0928	0.0696	0.0695

Source: Authors’ compilation.

Through the bearish phase of the study period (refer to Table 6), different performance evaluation techniques are employed to examine and compare the performance of SRI in the select developing and developed countries. A closer look at the traditional measures of risk–return exhibits the socially responsible index beating the conventional index and market counterparts in the USA as well as both the select emerging countries. Even as market index excess returns topple over SRI excess returns, it is offset by a higher standard deviation risk. It is the responsible investment strategy in the emerging country of India that earns higher excess returns accompanied by the lowest deviation, beta as well as the systematic risk through the market down-phase. The systematic risk stayed lower for socially responsible indices across regions implying a reduction of risk from the screening of industry and sectors. On the other hand, a consistently high unsystematic risk across the developing and developed counties implies a greater need for diversification by the socially conscious investor. Using risk-adjusted return measures of Sharpe and Treynor’s, it is evident that the SRI index continues to beat its general and market counterparts in the developing countries as well as the USA. Measuring index performance in terms of Jensen’s alpha, it is revealed that only the developing countries of India and China earn abnormal returns over a risk-free return, even during stressed times in the market. A positive M² measure indicates SRI index returns outperforming the benchmark in emerging countries, while the developed countries’ indices suffer negative values relative to the benchmark implying a penalty for holding ESG investments. A higher information ratio in the case of SRI indices in emerging nations highlights excess return generated from the amount of excess risk taken relative to the benchmark, while the conventional market continued to outperform the SRI index. Sortino ratio, which measures excess returns per unit of downside risk undertaken, is higher for the socially conscious investor in emerging countries but is beaten by the market benchmark in the case of the developed counterparts.

Table 6.

Performance Evaluation of SRI, Conventional and Market Benchmark Index Using Risk-Adjusted Measures in Select Developed and Developing Countries During the Bull Phase of the Market

Bear Market	Developed						Developing
Type	US			UK			India			China
Type	US ESG Leaders	US Market Index	US IMI Index	UK ESG Leaders Index	UK Market Index	UK IMI Index	India ESG Leaders Index	India Market Index	India IMI Index	China ESG Leaders	China Market Index	China IMI Index
Average returns	0.0010	0.0006	0.0010	−0.0055	−0.0044	−0.0041	−0.0003	−0.0060	−0.0065	0.0012	−0.0093	−0.0090
Excess return	0.0651	0.0647	0.0650	0.0327	0.0339	0.0341	0.0073	0.0016	0.0011	0.0085	−0.0020	−0.0017
SD excess	0.7508	0.7511	0.7509	0.1002	0.1014	0.1021	0.1388	0.1514	0.1546	0.2122	0.2091	0.2095
Beta	0.9999	1.0003	1	0.9706	0.9919	1	0.8908	0.9787	1	0.9657	0.9979	1
Systematic risk	0.7508	0.7511	0.7509	0.0991	0.1013	0.1021	0.1377	0.1513	0.1546	0.2023	0.2090	0.2095
Unsystematic risk	0.0064	0.0029	0	0.0144	0.0037	0	0.0172	0.0055	0	0.0641	0.0040	0
Sharpe’s ratio	0.0866	0.0862	0.0868	0.3266	0.3344	0.3341	0.0528	0.0105	0.0071	0.0400	−0.0096	−0.0082
Treynor’s ratio	0.0651	0.0647	0.0651	0.0337	0.0342	0.0341	0.0082	0.0016	0.0011	0.0088	−0.0020	−0.0017
Jensen’s alpha	−0.0001	−0.0005	0	−0.0004	0.0001	0	0.0063	0.0005	0	0.0043	−0.0003	0
M² ratio	−0.0001	−0.0005	–	−0.0008	0.0003	–	0.0071	0.0005	–	0.0101	−0.0003	–
Information ratio	−0.0129	−0.1548	–	−0.0279	0.0144	–	0.3679	0.0924	–	0.0431	−0.0102	–
Sortino ratio	0.0865	0.0860	0.0866	0.3164	−7.6686	0.3300	0.0769	0.0167	0.0116	0.0672	−0.0727	−0.0087
Modified Sharpe ratio	0.0866	0.0862	0.0868	0.3266	0.3344	0.3341	0.0528	0.0105	0.0071	0.0400	−0.0096	−0.0082

Source: Authors’ compilation.

To test whether a significant difference in mean of index returns of the select developed and developing countries exists, we employ independent sample t-tests. A P value greater than 5% indicates there is no significant difference in the mean returns of pairs of indices (Table 7). We observe that there exists a significant difference between the mean returns of the China ESG Index and General Index as well as the China ESG Index with broad market IMI Index during the bull phase of the market. On the other hand, it is the mean return of the ESG Index in developing countries like India which significantly differs from general and market index, thus implying safe-haven investment to the responsible investor.

Table 7.

Two-Sample Mean Comparison Test (t Test for Difference of Mean Returns)

	Bull Market				Bear Market
	US	UK	India	China	US	UK	India	China
MSCI ESG Leaders-MSCI IMI	0.1255	0.0985	0.1740	0.1255	0.2847	−0.0809	0.2488	0.2847
	(0.9003)	(0.9217)	(0.6862)	(0.0319**)	(0.7763)	(0.9357)	(0.0391**)	(0.7763)
MSCI ESG Leaders-MSCI Country	0.1253	0.1979	0.2159	0.1253	0.2931	−0.0682	0.2321	0.2931
	(0.9004)	(0.8434)	(0.6829)	(0.0447**)	(0.7699)	(0.9457)	(0.0363**)	(0.7699)
MSCI Country-MSCI IMI	0.0002	−0.1020	−0.0401	0.0002	−0.0082	−0.0129	0.0186	−0.0082
	(0.9998)	(0.9189)	(0.9681)	(0.9998)	(0.9935)	(0.1898)	(0.9852)	(0.9935)

Source: Authors’ compilation.

Notes: ***Significant at 0.99; **significant at 0.95; *significant at 0.90 (t values in parentheses).

Performance trends during the bullish phase of the financial markets exhibit the outstanding performance of the sustainable index of India that compensated the socially conscious investor the most for undertaking investment risk in responsible stocks measured by the positive value of net selectivity (refer to Table 8).

Table 8.

Ranking on the Basis of Fama’s Decomposition Net Selectivity Measure During the Bull Phase

Bull Market	Country	Indices	Risk Premium	Premium on Systematic Risk	Premium on Unsystematic Risk	Net Selectivity	Fama Decomposition Ranking
	US	MSCI US ESG Leaders	0.03%	0.03%	0.00%	0.00%	5
Developed		MSCI US Index	0.04%	0.03%	0.00%	0.01%	4
nations	UK	MSCI UK ESG Leaders	1.52%	1.38%	−0.01%	0.16%	2
		MSCI UK Index	1.36%	1.46%	0.00%	−0.10%	7
Developing	India	MSCI India ESG Leaders	0.43%	0.22%	0.01%	0.21%	1
nations		MSCI India Index	0.19%	0.23%	0.00%	−0.04%	6
	China	MSCI China ESG Leaders	0.94%	0.90%	0.01%	0.03%	3
		MSCI China Index	0.93%	0.93%	0.00%	0.00%	5

Source: Authors’ compilation.

In the table, it is exhibited that during the jubilant times, the UK closely followed the SRI trends in India to earn the second highest reward for engaging in socially responsibility stock selection. SRI China secured the third position for generating compensation for stock selection risk by socially conscious investors and also earned positive reward for the non-diversification risk of the index constituents. SRI index of US ranking faltered for not incentivizing the social screening of securities.

Bear conditions of the financial markets do not seem to have much impact on high returns arising from SRI index performance in developing countries (refer to Table 9). The gains from the net selectivity of responsible stocks are emphasized by the positive reward for stock selection in case of the Chinese SRI index, which managed to beat global indices even with negative risk premium for systematic and unsystematic risks of investments. Among all other peer indices, the SRI India is the second only index earning positive selectivity rewards for undertaking risks of screening the investments, as conventional and SRI indices of developed countries penalized stock-picking relative to the respective benchmarks.

Table 9.

Ranking on the Basis of Fama’s Decomposition Net Selectivity Measure During the Bear Phase

Bear Market	Country	Indices	Risk Premium	Premium on Systematic Risk	Premium on Unsystematic Risk	Net Selectivity	Fama Decomposition Ranking
	US	MSCI US ESG Leaders	6.51%	6.51%	0.00%	−0.01%	5
Developed		MSCI US Index	6.47%	6.52%	0.00%	−0.05%	7
nations	UK	MSCI UK ESG Leaders	3.27%	3.31%	0.03%	−0.07%	8
		MSCI UK Index	3.39%	3.38%	0.00%	0.00%	4
	India	MSCI India ESG Leaders	0.73%	0.10%	0.00%	0.63%	2
Developing		MSCI India Index	0.16%	0.11%	0.00%	0.05%	3
nations	China	MSCI China ESG Leaders	0.85%	−0.17%	−0.01%	1.02%	1
		MSCI China Index	−0.20%	−0.17%	0.00%	−0.03%	6

Source: Authors’ compilation.

We apply market model dummy variable regression on the select indices to study the impact of market conditions of bull and bear on the excess returns. This analysis helps to study the effect and role of the market in explaining the performance of SRI indices’ excess returns in select developed and developing countries.

Table 10 exhibits the significance of abnormal returns (α) and slopes (β) in a single index equation. We observe that the abnormal returns are positive and significant for the socially responsible indices in the aggregate bull period prevailing in India and China. During the bearish period, emerging nations of India and China recorded positive excess returns for SRI returns, implying safe-haven investment to the social responsibility investor. The abnormal returns recorded are found to be significant. The positive and significant slope of the index series highlights the positive impact of the market conditions of bull and bear on the studied responsible as well as general stock indices in all the select country indices. Further, the market conditions seem to have a strong market effect on the index performance of all developed and developing countries.

Table 10.

Abnormal Returns and Slope Beta of SRI Indices During the Bear and Bull Phases in Select Developed and Developing Countries

Indices	Bear		Bull
Indices	α₀	β₀	α₀ + α₁	β₀ + β₁
MSCI US ESG Leaders Index	−0.0001	0.9999**	−0.0003	0.9733**
MSCI US Country Index	−0.0005	1.0003**	0.0001	0.9875**
MSCI UK ESG Leaders Index	−0.0004	0.9706**	0.001443	0.9546**
MSCI UK country Index	0.0037	0.9918**	−0.0009	1.0000**
MSCI India ESG Leaders Index	0.0063**	0.8907**	0.0021*	0.9375**
MSCI India Country Index	0.0005	0.9787**	0.0004	0.9842***
MSCI China ESG Leaders Index	0.0043**	0.9656**	0.0032*	0.9632**
MSCI China country Index	−0.0003	0.9978**	0.0000	0.9983**

Source: Authors’ compilation.

Notes: ***Significant at 0.99; **significant at 0.95; * significant at 0.90 (t values in parentheses).

Discussions

The findings of the current study reveal that screening the securities for their ESG performance along with financial performance is not penalizing to the responsible investor in either developing or developed countries. Contrary to the modern portfolio theory (MPT), the responsibility indices do not underperform the market or the benchmarks during the documented period in developing or developed markets. The findings are relieving to the responsible investor who chooses to screen out socially irresponsible firms from their investments. Screening of securities is, in fact, positively rewarding in emerging countries, where the underpricing stemming from lower expectation garners the responsible investor with abnormal returns. In developed countries, on the other, the pricing and maturity of responsible investing results in lower excess return premiums.

Observing measures of risk and volatility in the select indices, a consistently high unsystematic risk across the developing and developed countries is highlighted falling in line with the MPT theory. The results call for greater diversification of ESG securities by the socially conscious investor. The systematic risk stayed lower for socially responsible indices across regions, implying a reduction of risk from the screening of industry and sectors. In the documented study period, the world economy faced some challenges post the subprime crisis such that mixed results for responsible investing in the USA and European countries have been observed due to greater volatilities in the market. Challenges of interest rate reduction, falling sales, job reductions and dwindling stock market saw firms investing in R&D suffer maximum volatility (Platzer, 2015; Quitzow, 2015; Schwert 2011).

Conclusion

The importance of SRI has grown exponentially over the past two decades. Developed countries have acted as flag bearers in bringing SRI to the mainstreaming investing and have been instrumental in giving impetus to its growth in the global arena. In the era of globalization, SRI in cross-country context as an investment strategy holds special relevance for the international investor. International responsible investors seeking cross-country diversification benefits, while also willing to monetize on country factors, have given impetus to the development of newer SRI vehicles backed by better disclosures by corporations, better litigation and regulatory requirements by the governments.

SRI acts as the catalyst in aligning financial growth with sustainable development. The study evaluated and compared the performance of socially responsible indices in select developed and developing countries across market conditions over 12 years. The study is unique in its attempt to present a comparative analysis of SRI indices against the general and conventional market indices in representative developing and developed countries, investigated through market conditions of bull and bear.

We investigate the performance of SRI in the developed and developing countries, namely, the USA, the UK, India and China, covering a major part of the global economy. Studying the series statistics on the select indices, it is seen that MSCI ESG indices of developing countries beat the general and market benchmarks on the first moments. Notably, only the UK, India and China ESG indices had a lower standard deviation than the market. SRI indices, thus, are not penalizing to the responsible investor seeking to combine ethical goals with financial objectives in developing economies of India and China as well as developed countries like the UK. Mixed results were observed for higher moments of mean-variance analysis.

Evaluating the various traditional and risk-adjusted-performance measures in select countries during the bull phase of the market, it is noted that the responsible indices in emerging countries beat the general index as well as market benchmark by all traditional and risk-adjusted measures of evaluation. SRI Index of the UK, too, successfully beats its general and market counterpart using various risk-adjusted measures of performance, implying positive reward for the incremental risk undertaken. Interesting results were obtained for the bear market, as the SRI indices consistently beat its market counterparts in emerging nations, implying security and premium reward to the socially conscious investor even during the stressed times of the market. Responsible investing in developed markets, on the other hand, gave mixed results based on various traditional and risk-adjusted measures.

Testing the means of the responsible indices against general indices and market benchmarks, it is noted that the performance of India ESG is significantly different from the general and market index during the bull market. The social responsibility index of China had significantly higher returns than its counterparts during the bear phase.

The Fama decomposition method of ranking indices based on the reward for net stock selectivity skill exhibits socially responsible indices in India, China and the UK securing the top ranks during the bull period. Notably, only socially responsible indices in developing countries hold top positions during the bearish phase of the market. Dummy variable regression was run to investigate the impact of the market conditions of bull and bear on excess returns of the socially responsible as well as general indices. Continuing the superior performance over developed countries, the developing countries of India and China earned significant positive excess returns, outperforming the general indices, in bear and bull conditions, respectively.

Implications

The current study emphasizes the difference in performance of SRI across countries based on their level of economic development, other than prevalence of country factors such as degree of the legislative and regulatory power of the government, cultural values of people, social, economic and environmental challenges, due to the difference in the orientation of economies and social and living standards of the population. The study has implications for the following sectors of society.

Developed and developing countries: In an attempt to strike a balance in financial and sustainable goals and step towards holistic development, there is a need for the developing and developed countries to come together and form conventions prescribing, implementing and enforcing proper and uniform codes of CSR and ESG disclosures. The unification of sociopolitical and economic powers held by developed countries with the reserve of resources in developing countries is imperative for sustainable growth.

Corporate houses: Businesses across developing and developed countries are called out to join hands, network and share sustainable business practices and strategies for integrated efforts towards global sustainability.

Money managers: Money managers have a role in orienting investors in developing countries to sustainable instruments, while helping investors in developed countries to diversify their portfolio by including international ESG securities.

Regulators: Governments and regulators in developing countries have a major role in drafting, implementing and enforcing ESG code of conduct in the financial markets, while they can act as catalysts and monitors for strategy penetration in developed countries.

Investors: The active investor seeking country benefits in the globalization context has a lot to gain from the diversification in not just cross-border securities but cross-border sustainability wave.

A mainstream strategy in developed markets, SRI is pertinent in developing markets context with its ability to bridge seemingly opposite motives of corporate financial orientation and social ethics.

Footnotes

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The authors received no financial support for the research, authorship and/or publication of this article.

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