Responsible Investing: Delivering Competitive Performance
Growing interest in Responsible Investing (RI)—also known as Socially Responsible Investing (SRI)—raises an important question: Does pursuing social goals—limiting the range of potential investment opportunities—require sacrificing performance?
A TIAA analysis of leading RI equity indexes over the long term found no statistical difference in returns compared to broad market benchmarks, suggesting the absence of any systematic performance penalty.
Moreover, incorporating environmental, social and governance (ESG) criteria in security selection did not entail additional risk. RI indexes and their broad market counterparts had similar risk profiles, based on Sharpe ratios and standard deviation measures.
Although return patterns were similar over the long term, there were significant return and tracking error differences between RI indexes and broad market benchmarks over shorter periods. By narrowing the range of eligible investments, the RI process introduced biases that caused short-term index performance to deviate from broad market benchmarks, resulting in tracking error.
RI index construction methodology is an important determinant of tracking error. Investors should consider specific ESG methodology and the relevant market benchmark when selecting an RI strategy.
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