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J

Ö N K Ö P I N G

I

N T E R N A T I O N A L

B

U S I N E S S

S

C H O O L JÖNKÖPING UNIVERSITY

T h e f i n a n c i a l p e r f o r m a n c e o f

e t h i c a l f u n d s

A c o m p a r a t i v e a n a l y s i s o f t h e r i s k a d j u s t e d p e r f o r m

-a n c e o f e t h i c -a l -a n d n o n - e t h i c -a l m u t u -a l f u n d s i n U K

Master Thesis

Author: Elena Shloma Tutor: Johan Eklund

Carl-Henrik Olaison Jacobsson Jönköping June 2009

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Master Thesis in Economics

Author: Elena Shloma

Tutor: Johan Eklund, Carl-Henrik Olaison Jacobsson Date: June 2009

Title: The financial performance of ethical funds. A comparative analysis of the

risk-adjusted performance of ethical and non-ethical mutual funds in UK

Key terms: Socially responsible investments, ethical funds, corporate social responsibility,

risk-adjusted performance, management fee.

Abstract

The review of the ethical funds literature shows the significant growth of the Socially Re-sponsible Investments (SRI) in the last few decades. The increase of the interest towards SRI indicates that ethical issues have become more essential for the investors. However the number of surveys reveals that financial performance remains of an important concern for the socially responsible investors. Therefore the benchmark analysis of the expected re-turns and management fees of the ethical mutual funds is chosen as a topic for this thesis research. The risk-adjusted measures are used to analyze and compare the performance of the ethical and non-ethical mutual funds in United Kingdom. The analysis does not indi-cate the significant difference in the expected returns between the two groups of funds. However this study concludes that on average ethical funds charge higher management fees. Thus investing in ethical funds is more costly but gives about the same returns as in-vesting in conventional funds.

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List of Abbreviations

BAT: British-American Tobacco CSR: Corporate Social Responcibility DEI: Direct Ethical Investment

EIRIS: Ethical Investment Research Service

FTSE: The Financial Times and the London Stock Exchange Group ITG: Imperial Tobacco Group

KLD: Kinder, Lydenberg and Domini Research & Analytics, Inc MSCI: Morgan Stanley Capital International

OEIC: Open Ended Investment Company OLS: Ordinary Least Squares

PMInt: Phillip-Morris International SIF: Social Investment Forum

SRI: Socially Responsible Investments

UK: United Kingdom (refers to the United Kingdom of Great Britain) US: United States (refers to the United States of America)

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Table of Contents

1 Introduction ... 1

1.1 Background ...1 1.2 Problem discussion ...3 1.3 Method ...5 1.4 Purpose statement ...5 1.5 Research questions...6

1.6 Originality of the research...6

1.7 Scope and Delimitations...7

2 Background and Literature Review ... 9

2.1 Profile of the ethical investors...11

2.2 Corporate Social Responsibility...12

2.3 Ethical funds ...13

2.3.1 Mutual funds ...14

2.3.2 Socially Responsible Investments ...15

2.3.3 Financial performance of ethical funds ...17

3 Method and Data ... 19

3.1 Method ...19

3.1.1 Modigliani and Modigliani model ...20

3.1.2 Cross section regression ...21

3.2 Data...23

3.2.1 Samples ...23

3.2.2 Data gathering ...24

3.2.3 Data for the cross-section model and Ethical Rating ...26

4 Empirical Results and Analysis ... 30

4.1 Characteristics of the data sample ...30

4.2 Results of the matched pair analysis ...33

4.2.1 Financial performance ...33

4.2.2 Management fee ...37

4.3 Results of the regression analysis ...38

4.4 Analysis of the results...41

5 Conclusion ... 43

6 Suggestions for the further research ... 44

References ... 46

Appendix ... 49

List of Figures

Figure 1 The SRI through the ethical funds...10

Figure 2 The data gathering procedure...24

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Figure 4 The distribution of the funds in the sample among the sectors ...30

Figure 5 Annual Management Fees. ...32

Figure 6 Front Loads. ...33

List of Tables

Table 1 The Ethical Rating ...29

Table 2 The size of the funds in the sample...31

Table 3. The funds which have the tobacco companies among the 5 largest holdings and the tobacco companies they invest in...32

Table 4 Summary of the empirical results ...35

Table 5 The output of the OLS regression #1. ...38

Table 6 Correlation Matrix ...38

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1

Introduction

The background part of this thesis provides a small introduction to the concept of the ethi-cal investments and explains the reasons why some analysts assume that there should be a difference in financial performance between ethical and conventional funds. Further the purpose of the research and the main research questions are formulated. Finally the origi-nality and the delimitations of the thesis are discussed.

1.1

Background

This thesis analyses the performance of the ethical funds in UK. When analysts and inves-tors call one fund ‘ethical’ they generally imply that the fund is focused on the socially re-sponsible investments (SRI). Ethical funds are also known as ‘green’, environmental and socially responsible funds. Different nomenclature is used in different countries(Beal and Goyen, 1998). Within this thesis work all the terms are used as synonyms and refer to the funds which promote SRI and marketing themselves as been ethical. These funds allow in-vestors to integrate their personal values and social concerns with their investment objec-tives (DEI). The SRI approach implies that ethical funds screen the companies according to some type of ethical criteria and invest in these which show a high quality of corporate social responsibility (CSR). Generally the CSR is defined in the academic literature as a way of solving the potential conflict between the management of the company and the wide spectrum of the stakeholders, including employees, customers and the general community (Bird et al. 2007). The question concerning the area of the management’s responsibilities towards the stakeholders is addressed by many analysts. From the neo-classic economists’ viewpoint the main responsibility of the management is to maximise the market value of the company (Bird et al. 2007). However some other analysts, investors and even govern-ment include the social and environgovern-mental issues into the CSR. For example Kinder, Lydenberg and Domini Research & Analytics, Inc., which create the one of the most commonly used CSR indices, evaluates companies based on the following issues: commu-nity relations, diversity, employee relations, human rights, and product quality and safety, environment and corporate governance (KLD). Within this research the broad definition of the CSR is used. The SRI and CSR are often interpreted by the analysts as the same con-cept. However SRI looks from the viewpoint of the investors, while CSR looks from the viewpoint of the firms. The more detailed description of the SRI performed by the ethical

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funds and its relationship with the CSR is discussed in the Background and Literature Re-view chapter.

Every year the studies on the socially responsible investments show the increasing interest towards SRI among the individual and institutional investors.

For the last decade the SRI market has been growing every year. The amount of the social responsible investments (SRI) in Europe has increased from €1.033 trillion in 2005 to €2.665 trillion at the end of 2007 (Eurosif, SRI Study, 2008). Over the same period the MSCI Europe index grew 16.16%. According to the Eurosif research it means that the real market growth for the total SRI market is 85.5% over two years. The 2007 Report on So-cially Responsible Investing Trends in the US demonstrates that one of nine dollars in-vested in the market funds is inin-vested in SRI portfolios (SIF). The same study documented the increase in the number of ethical funds and the amount of the socially responsible in-vested assets. According to Avanzi SRI Research, there were 388 green, social and ethical funds domiciled in Europe on 30 June 2006.

These trends show that nowadays not everyone agrees that ‘the main responsibility of the business is to increase its profits‘(Friedman, 1970). Apparently the growing number of ethi-cal and sustainable funds proves that there is a demand for SRI. It seems that high return is not any longer the only main factor which influences the investment decisions. Some inves-tors want to make sure that their money do not support the war in Sudan, or are not in-vested in tobacco industry. They might be concerned about particular ethical issues, like environmental protection, ethical employment practices, conservation and recycling and others. This implies that it is possible to find a fund which not only manages your money to achieve the highest returns, but as well satisfies your non-material needs.

The socially responsible investments can be defined as ‘…a set of approaches which in-clude social or ethical goals or constraints as well as more conventional financial criteria in decisions over whether to acquire, hold or dispose of a particular investment’ (Cowton, 1999, p. 60). SRI implies screening of the companies included in the investment portfolios based on social, environmental and good corporate governance criteria, shareholders advo-cacy and community investing and others (SIF, Socially Responsible Investing Facts). The society of the socially responsible investors includes both individual and institutional inves-tors. Institutional investors, including the ethical funds, represent the largest and fastest growing segment of the SRI in the world (SIF).

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However, there is some skepticism about ability of the ethical funds to provide about the same returns as the conventional funds and give their clients an additional moral satisfac-tion free of charge. It is argued that ethical funds have higher transacsatisfac-tion costs and man-agement fees because they need to collect special information concerning the ethical prac-tices of the firms (Michelson et al., 2004). Therefore one might expect to pay more for in-vesting in the ethical funds. Making the decision about putting money in the certain fund investors traditionally consider the costs of the investment and performance of the fund. There are some surveys and studies which show that investors who put money in the ethi-cal funds are different from the conventional investors and they have different motivations when making an investment decision (Beal et al., 2005, McLachlan and Gardner, 2004). However the same studies indicate that the costs of the investments, as well as financial re-turns remain an important consideration when investing in ethical funds. Therefore the need to analyze the performance and the management fees of the ethical funds remains. This thesis seeks to investigate what is the difference between investing in the ethical and conventional funds, from the perspective of costs and profit. Within the framework of this research the attempt is made to compare the costs and the returns of the investment op-portunities offered by ethical funds with investing in non-ethical funds. The research is conducted in two directions, comparable analysis of the financial performance of two groups of the funds and the analysis of the difference in the management fees charged by the funds. The object of the research is the group of the Unit Trusts and Open Ended In-vestment Companies (OEICs) in United Kingdom. Unit Trusts and OEICs are pooled in-vestments that provide investors with the ability to invest in a larger number of shares si-multaneously. They are both open ended which means that the size of each fund can vary according to supply and demand. Both the Unit Trusts and OEICs represent the same in-vestment concept, the main difference is when you invest in a Unit Trust you buy a unit, which means a portion of the total fund, OEICs issue shares (Trustnet, Unit Trusts and OEICs Guide). Both the Unit Trusts and OEICs are types of mutual funds, and are used as the representatives of the society of institutional investors for the purpose of this re-search. The UK market is chosen as the object of the research since it is the largest SRI market in Europe (Eurosif European SRI Survey, 2008).

1.2

Problem discussion

While social responsible investors integrate the environmental and social values in the in-vestment decision-making process, return on inin-vestment remains of important concern to

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them (McLachlan and Gardner, 2004). In the Sparkes’s survey (1998) it was shown that on-ly one third of the investors would invest ethicalon-ly if returns were slighton-ly lower than for comparable conventional funds, however this percentage drops rapidly if the return for ethical funds are significantly less than for conventional funds (cited in McLachlan and Gardner 2004, p 12). Moreover to encourage the socially responsible investments the ad-vocates of the ethical funds often emphasize that ethical funds provide at least the same re-turns as the conventional funds (DEI). There are even some expectations that ethical funds are doing financially better than conventional funds. The main reason behind these expec-tations is that ethical funds screen the companies and choose to invest in these which are concerned about the corporate social responsibility (CSR). There is some evidence that CSR behavior has a positive effect on the market value of the firms and that ethical firms are more sustainable than non-ethical firms. Therefore the portfolios that consist of the shares issued by the firms with high quality of CSR are considered to be more sustainable and produce higher returns. There is a number of reasons to expect the positive effect of CSR on the corporate financial performance. First of all, companies with the high stan-dards of CSR avoid paying the consequences of the non-ethical behavior, such as lawsuit judgments, government fees and others(Bird et al., 2007). There are even examples when such behavior leads to the bankruptcy1. Second, CSR is believed to create the intrinsic

mo-tivation for the employees, which is proved to be associated with the more efficient per-formance (Millington et al., 2007). In general the ethical firms are expected to perform bet-ter in the longer time horizon than firms which are not concerned about ethical issues (Cummings, 2000).

In contrast there is as well a number of analysts who believe that the screening process has a negative effect on the financial performance of the ethical funds. Ethical funds exclude many companies from their portfolios, for the reasons other than weak financial perfor-mance. It is common for the ethical funds to avoid investments in the certain industries, regardless if such investments might provide high returns or not. For example ethical funds do not invest in tobacco companies, which are often among the biggest holdings of the mutual funds and give the investors relatively high returns2. What is more, most of the

funds do not put money in the companies with the low quality of the corporate governance

1For example in case of Enron, Parmalat and Worldcom (Becchetti et al. 2007)

2The presence of tobacco companies among the main holdings of the companies in the sample is discussed in the Method and Data chapter of this thesis.

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or these which are not concerned about CSR. Therefore ethical investments are believed to be less diversified and hence more risky for the investors than traditional invest-ments(Michelson et al., 2004). That is why some analysts assume that ethical funds in gen-eral show poorer financial performance than the conventional funds

It is argued as well that ethical funds charge higher management fees than conventional funds, since the screening process involves higher transactional costs for the ethical funds (Michelson et al., 2004). This thesis research combines the analysis of the financial perfor-mance of the ethical funds with the analysis of the management fees charged by these funds in order to investigate the costs and profits of investing ethically.

The arguments above show that there are discrepant opinions whether ethical funds are expected to perform financially better or worse than conventional funds. Moreover some analysts point out that there is a lack of the empirical research on the financial performance of the ethical funds (Kreander et al., 2005, p.1466). In addition the relationship between the financial performance and the management fee is analyzed to contribute to the conclusions about costs and returns of investing in the ethical funds.

1.3

Method

The matched pair analysis is used to compare the performance of the ethical and conven-tional funds. The two matched samples of the ethical and convenconven-tional funds were created and the performance of the each ethical fund was compared with the performance of the similar non-ethical fund and with the benchmark. This method was chosen because it al-lows to investigate if the investment approach of the ethical funds has an effect on the fi-nancial performance of the funds assuming other characteristics being equal. The fifi-nancial performance is analyzed using the risk-adjusted Modigliani and Modigliani (M2) measure. The risk-adjusted measures are commonly used for the benchmark analysis of the funds’ financial performance, since it facilitates the comparison of the different funds. The differ-ence in the management fees between the two groups of the funds (ethical and conven-tional) is analyzed using the matched samples and an additional regression model.

1.4

Purpose statement

The main purpose of this study is to analyze if there is a difference in the performance be-tween ethical and conventional funds. These two groups of the funds provide different services, have different clients and invest in different companies. Thus there is a general

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expectation that ethical and conventional funds should show different financial perfor-mance. Particularly this study is focused on the difference in the portfolio returns and the management fees between two groups of the funds.

1.5

Research questions

Based on the problem discussion the following main questions emerge:

 Is there any difference in the performance between ethical and non-ethical funds?  Is there any difference in the management fee between ethical and non-ethical

funds?

In addition the following question will be answered to expand the research on the fund’s financial performance:

 Is management fee charged by the fund related to the performance of the fund?

1.6

Originality of the research

While this thesis is based on the previous researches in the area of SRI, there are some dis-tinctions which contribute to the studies on the ethical funds.

First, in the previous researches such measures as the Sharpe ratio, the Jensen measure and the Treynor ratio are used to estimate the risk-adjusted performance. Despite the fact that these measures are the most commonly used to compare the funds, they have received some criticism for been difficult to interpret (Wiberg, 2008). Thus in this work the Modi-gliani and ModiModi-gliani (1997) M2-measure is used, since it is considered to be more easily understood by average investor and therefore more helpful for measuring the risk-adjusted performance.

Second, in the previous studies performance of the ethical funds was compared with the same benchmark for every fund. It means that all the funds in the sample were from the same investment universe. Within the framework of this thesis research the attempt to overcome this limitation is made. The sample includes the ethical and non-ethical funds in-vesting in the different sectors like UK market, Global market, Asia and Pacific market and others. Obviously it would not be correct to compare the funds in the sample with the same benchmark. For this reason the appropriate benchmark was chosen for each of the

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funds. The benchmark sample includes for example FTSE All Share index for the funds investing in UK, or MSCI AC Asia Pacific ex Japan index for the funds investing in Asian markets.

Next, within this research the attempt is made to combine the research on the financial performance of the ethical funds with the analysis of the management fees. The goal is to take a look at the ethical investments from viewpoint of the individual investors, who put money in the funds. Individuals choose between investing in the ethical and non-ethical funds, and as it is discussed above, on the first place they consider the returns and the costs of the investment opportunities in the different funds. Therefore the simultaneous analysis of the management fee and the financial performance of ethical and non-ethical funds helps to investigate the pros and the contras of investing ethically.

Finally, the more contemporary data were collected. The data on the historical prices of the mutual funds’ shares was collected for the period of 33 months, from January 2006 to Sep-tember 2008. This time horizon was chosen for the several reasons. First of all some funds in the sample were launched recently, so for many funds there is no information on the his-torical price before the year 20063. Second, the most recent data on the performance was

excluded from the research due to the possible effect of the global financial crisis of 2008-2009 on the funds’ share prices. It is well known that ethical funds avoid investing in some industries which were highly damaged by the crisis (like oil and gas, natural resources). However it was noticed that some ethical funds in the sample invest heavily into financial sector and money market. Hence, to avoid the possible discrepancy of the results due to the influence of the financial crisis the data was collected for the period before the crisis had an impact on the share price. The sharp decrease in the price of the mutual funds shares for all the funds in the sample is noticed after the September 2008. Thus latest share prices collected are on the 1stof September, 2008.

1.7

Scope and Delimitations

The scope of this thesis is to analyse the performance of the Unit Trusts and OEICs in the United Kingdom for the period from January 2006 to September 2008. The study is limited to the group of the funds which profiles are published on the Trustnet the Financial

3Some funds in the sample were launched after the research start date, for these funds the annualized returns were calculated from the launch data. It should not influence the benchmark analysis, since it does not ef-fect the risk-adjusted measures. The same approach is used by Mallin et al., 1995, and Kreander et al., 2005.

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press Company website database. The Trustnet database contains information about the 2410 Unit Trusts and OEIC in the United Kingdom. Obviously the study sample suffers from the survivorship bias, but since it affects both the ethical and non-ethical funds it should not affect the comparative analysis.

Another limitation which is worth to be mentioned is that the ethical status of the certain fund is difficult to define. It is hard to assess which fund can be considered ethical and which can be considered non-ethical. Mostly the funds characterize themselves as been fo-cused on the socially responsible investments, which is not easy to verify. Moreover con-ventional funds generally do not state in their profiles that they are non-ethical and it is hard to investigate if they consider the social issues in their investment strategies or not. Thus it is hard to create the sample of purely ethical funds or purely non-ethical funds to conduct the comparative analysis. To reduce the impact of this limitation the ethical rank-ing is used and the main holdrank-ings of the funds in the samples are analysed.

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2

Background and Literature Review

The phenomenon of the ethical funds is analysed in the academic literature from different viewpoints and different perspectives. Some studies focus on individual investors who put money in the ethical mutual funds and analyse the reasons behind this investment decision. Others are interested in the investment approach of the ethical funds and their objectives or analyse the profile of the companies included in the holdings of the ethical funds. Some, like this study, are interested in the financial performance of the ethical funds in compari-son with the conventional funds. The SRI is a complex phenomenon that involves many individuals and institutions. In this chapter the attempt is made to look at the different as-pects of the ethical investments and to analyse the different viewpoints and reasons behind SRI. However on the first place this thesis research concerns the financial performance and the management fees of the ethical and non-ethical funds. The background discussed in this chapter serves the main purpose of this research and explains the previous studies on the ethical funds from the perspective of financial performance. The emphasis is made on the determinants of the performance and the approaches to the performance analysis. To structure the studies reviewed in this chapter and to highlight the most important topics of this research, the simplified scheme of the investing into the ethical funds is cre-ated(Figure 1). The main purpose of this scheme is to provide some illustration of how this chapter is organised. The ethical funds are discussed from viewpoints of three main parties involved in the SRI through the funds: individual investors, firms and ethical funds them-selves. Individual investors make a decision about putting money into the certain fund, af-ter that the fund makes a decision about purchasing the shares of the certain companies. The scheme shows which aspects influence the investment decisions at each stage, and on which side these aspects occur. Finally, these investment decisions result in the certain portfolio the ethical mutual fund holds and determine the financial performance of the fund.

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Figure 1 The SRI through the ethical funds

Source: Made by the author

The chapter is organised using the scheme on the Figure 1, the various aspects of the ethi-cal investments are analysed and at the end of the chapter all of them converge to the ques-tion about the financial performance of the ethical funds. First two parts of this chapter look at the socially responsible investments from outside the ethical funds and discuss the external factors which influence the financial performance of the ethical funds. First part is devoted to the studies on the individual investors and the second part analyses the social responsibility of the firms. In the last part the ethical funds are discussed directly and the internal factors of the funds’ financial performance are analysed.

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2.1

Profile of the ethical investors

The growth of the SRI in the world indicates that the demand for SRI from the individual investors has increased in the last decade. This part includes the profile of the ethical inves-tors and discusses the determinants of the investment decision. In general the surveys dis-cussed in this chapter show that ethical investors are demographically different from the conventional investors. However they as well reveal that ethical and conventional investors are more similar in their incentives, than it might be expected, since both put the financial reward on the first place when making an investment decision.

Several studies show that socially responsible investors are generally younger, better edu-cated and have a lower income than conventional investors (Rosen and Sandier, 1991, McLachlan and Gardner, 2004). Research conducted by KPMG (2000) suggests that 80% of 25-39 year olds as compared to 72% of 40-59 year old would consider investing ethically (cited in McLachlan and Gardner, 2004). Rosen and Sandier documented that 60% of the ethical inventors had graduate degrees, but currently earned 15% less than the conventional mutual fund investors, possibly because they were in earlier stages in their careers. As well it was noticed that ethical investors are more likely to be female than conventional inves-tors.

The ethical investment research literature traditionally suggests three reasons for people in-vest in socially responsible funds: for superior financial returns; for non-wealth returns; to contribute to social change (Beal et al., 2005). The review of the literature on the ethical in-vestments, conducted by Beal et al.(2005) concludes that ethical investors are motivated by a combination of financial returns and non-wealth factors. The ethical investors are inter-ested in all three of proposed objectives, however the social change factor is the least im-portant in the decision to invest in SRI funds. In contrast, the financial return remains the main important factor for most of the investors, when making the decision to put money in the ethical fund. There is a number of studies which support this hypothesis. The results of the Sparkes’s study (1998) are reviewed in the Introduction chapter. Similarly, the survey conducted by McLachlan and Gardner (2004) using the sample of 55 conventional and 54 ethical investors showed no evidence that financial returns are more important for conven-tional investors than for socially responsible investors.

The studies on the ethical investments conclude that ethical investors seek to align their personal values with the investment objectives, and contribute to the society. Ethical

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inves-tors believe that SRI funds produce at least the same returns as the conventional funds and at the same time ensure the high CSR standards in the companies they invest in.

However it is often mentioned in the studies on the SRI that ethical funds are rather make people to feel better about themselves, than actually change the society. Investing in the SRI funds does not affect the environment or businesses directly, but makes people believe that eventually SRI will make a change (Beal et al., 2005). Therefore there is a strong as-sumption that labeling themselves as ‘ethical’ mutual funds seek to attract the new type of investors, and SRI is nothing more than a new marketing strategy. Some researches which support this hypothesis are revealed in the last part of this chapter.

2.2

Corporate Social Responsibility

The theory on the corporate social responsibility is analysed in this part. Traditionally CSR is assumed to be the main source of the financial performance of the ethical funds. The screening of the firms according to the socially responsible criteria performed by the ethical funds involves that the ethical funds intend to invest in the companies with high quality of CSR. Some analysts note that SRI and CSR are basically the same concept that business should generate the wealth for society. CSR takes a look from the viewpoint of the firms, while SRI looks from the viewpoint of investors, including mutual funds. Thus the per-formance of the ethical funds is believed to be dependent on the relationship between cor-porate social responsibility and corcor-porate financial performance at the scale of the individ-ual firm (Mill, 2006). Explicitly, if there is a difference in the performance between the so-cial responsible and conventional firms, there should be a difference in the performance between the ethical and conventional funds.

There are several reasons why analysts assume that CSR can increase the value of the com-pany. Bird et al.(2007), mention such factors as; (1) activities that result in an immediate cost saving, which increase the profitability and therefore the company’s market values, like becoming more energy efficient, (2) Other activities that bring reputational benefits (good-will) to the company which increase both profitability and market valuation, (3) Other ac-tivities that dissuade future action by government and other regulatory bodies which might impose significant costs on the company. Another value increasing sources of the CSR is proposed by Yellen (1984), this study suggests that CSR creates the intrinsic motivation for the employees, that improves productivity at the same costs. These motives make managers to improve the corporate social responsibility and anticipate the increase in the market

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value. As it might be expected there is as well an opposite opinion on the link between the CSR and the market value of the firm. Some analysts claim that there are many other im-portant events influence the financial performance of the firm, so CSR cannot have an ob-servable influence on the market value (Ullman, 1985). Other say that improving CSR is as-sociated with the high expenditures which put the company at a comparative disadvantage and effects negative its market value (Aupperle et al., 1985)

There are different theories on the relationship between CSR and the market value of the company. However it is important to take into consideration the results of the empirical re-search. One of the common ways to analyse the effect of the CSR on the market value is to check for the abnormal returns when company engages in the SR activities. One of the common indicators of company applying the CSR principles is inclusion of the company in one of the CSR indices. The most commonly used indices are Dow Jones Sustainability World Index, Domini 400 Social Indices, FTSE4Good Indices. They track the perfor-mance of the CSR world leading companies. There is empirical evidence that companies inclusion (exclusion) from the Domini 400 Social Index, leads to the abnormal positive (negative) returns (Becchetti et al., 2007). However the negative effect turned out to be much stronger than positive effect. Some other empirical tests show that the effect of the CSR activities on the firms’ performance is significant only in the short time horizon. Lo-pez et al.(2007), using the Dow Jones Sustainability World Index, showed that there is no significant difference in the revenues of the firms included in the index and not included in the index during the 7 years period.

2.3

Ethical funds

This part addresses the ethical mutual funds directly and explains the investment approach of the ethical funds and other determinants of their financial performance. First, the studies on the mutual funds reviewed, since the financial performance of the ethical funds is ana-lysed in this thesis research using the conventional approach to the analysis of the mutual funds’ performance. Than it explains how the ethical funds are different in their investment strategies from the rest of the mutual funds, and what does the SRI approach implies. Fi-nally the effect of the SRI on the financial performance of the ethical funds is discussed and the results of the previous studies in this area are reviewed. Also some criticism of the SRI approach as being used solely for the marketing purpose is presented in this part.

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2.3.1 Mutual funds

The object of this research is the sample of the mutual funds in UK. Thus there are some background studies on the mutual funds which are important for this thesis. First of all the most common approach to the benchmark analysis of the financial performance of the mutual funds is using the risk-adjusted measures. The reason behind this approach is to make the funds comparable with each other and the benchmark. This method is used for example by Sharpe (1966) and Jensen (1968).

It is generally accepted to take into consideration both the expected risk and return of the portfolio when analysing its financial performance. The higher return of the investment normally implies higher risk associated with this investment. The task of the investor is to select among the different portfolios the one that he considers the most desirable, based on his particular feelings regarding expected risk and return (Sharpe, 1966). Therefore there is a need for approach which allows to compare the portfolios characterised by the different expected returns and risks. To make the portfolios comparable the risk-adjusted measures were proposed by several analysts. There are different measures of the risk-adjusted per-formance, however they all express the same concept. The idea behind the risk-adjusted method is to bring all the analysed portfolios to the certain level of risk (to the benchmark level) and to investigate which portfolio shows the best expected returns at this level of risk. Namely it makes the different combinations of the risk and return comparable with each other, by showing how the return of the portfolio would change if the risk of this portfolio was adjusted to the certain level. There is a number of the risk-adjusted measures proposed by the different analysts. In this study the Modigliani and Modigliani (M2) meas-ure is used, the M2 approach is discussed in the Method and Data chapter.

Another question which is considered in this research is the influence of the various factors on the financial performance of the mutual funds. The most commonly considered factors are the size, the age and the management fee. There are some studies which show that the small funds on average perform better than the big funds. Gallagher et al.(1998) analyse so called small funds effect on the sample of 46 mutual funds and conclude that small funds show higher returns than bigger funds. However this effect disappear when the funds are compared using the risk-adjusted measures. In the Kreander et al.(2005) research it was shown that the size of the fund is not related to the performance as well as the age of the fund, while the management fee is argued to have a significant effect on the performance.

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The influence of the size and the age on the performance is taken into consideration within this thesis research, and for this reason the matched sample approach is used to avoid the influence of the certain characteristics on the performance of the ethical funds.

Regarding the management fee charged by the funds there is some evidence that the fee is related to the financial performance. However the results of the studies on the determi-nants of the financial performance of the mutual funds are inconclusive about whether this relationship is negative or positive. In Kreander et al.(2005), the regression analysis per-formed using the sample of the mutual funds in UK showed that the fee coefficient is posi-tive and significant. While Grinblatt and Titman (1994) documented a significant negaposi-tive relationship between fee and the Jensen measure for US mutual funds. This thesis seeks to obtain more evidence on the relationship between the management fee and the financial performance in the mutual funds.

2.3.2 Socially Responsible Investments

This part explains what does the SRI approach implies, how the ethical funds are different in their investment strategies from the rest of the mutual funds and what are the ethical cri-teria they apply.

Ethical investments have a long history. In the 18th century under the influence of the

Catholic Church many individuals refused to do business with the firms involved in the slave trade, alcohol or gambling (Schwartz, 2003). The ethical issues historically were taken into consideration by many groups and communities, like Jewish community or Quakers community. But the peak growth of the ethical investments was noticed after the 1980. There are several factors boost the growth of the ethical investments. Among others there are such important factors as growth of the business ethics and the corporate responsibility movements, the growing evidence that ethical funds produce the sufficient returns, growth of advertising of the ethical funds, growth of sustainability indices and other (Schwartz, 2003).

It is argued in many papers what type of funds can be considered ethical and what are the ethical criteria. Some of the analysts argue that ethical criteria are individually established in every certain company and depend on the corporate policy and the ethical codes (Cowton, 1999). As well there are various guidelines and documents which help funds to adopt the SRI principles. Most of the ethical funds use two approaches, negative and positive, when screening the companies included in their portfolio (EIRIS, 2008). The negative approach

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implies that funds avoid investing into the non-socially responsible companies (Schwartz, 2003). For instance ethical funds avoid investing in the tobacco, gambling, and alcohol in-dustries, into the companies which exploit the animal testing and violate the human rights. The positive approach implies that ethical funds tend to invest in the companies with good corporate governance, which promote the environmentally friendly behaviour, protect hu-man rights, et cetera. There are different acts and documents which provide the guidelines for the ethical funds. Since this research focuses on the mutual funds in UK it is worth to mention that most ethical funds in UK choose their criteria from the list of the 300 criteria provided by the Ethical Investment Research Service (Mackenzie, 1998).

There are several reasons why the certain industries might be considered unethical by the mutual funds. Some of them, like alcohol and tobacco are considered both addictive and dangerous (some of the analysts include unhealthy restaurants and food producers to this category as well) (Schwartz, 2003). However some of the industries which are often ex-cluded from the ethical funds portfolios are questioned as been unethical. For example gambling harms people, brining financial problems and even suicides, but even though some analysts argue that it is similar to the investing in the stock markets, since people vol-untary engaged in it and aware about the possibility of losing money (Schwartz, 2003). Some of the funds avoid the certain gas and oil companies, since many of them imply the environmental pollution4and are not considered to be sustainable due to the decreasing of

oil and gas resources.

Generally ethical funds screen the companies and look for these, which consider the social responsible objectives. It is argued that companies and funds behave socially responsible, not because they concerned about social issues, but rather to stay competitive on the mar-ket. Promoting racism or destroying the nature, companies become less attractive for the customers and are threatened to get penalties from the government. For this reason it is ar-gued that ethical behavior does not mean that the company step towards social responsibil-ity in a positive sense (Hellsten and Mallin, 2006). It is argued in the Beal et al.(2005) study that screening firms according to the socially responsible criteria allows ethical funds to create a new market niche, rather than anticipate the positive changes in the society. There-fore labeling themselves as ethical is often considered a new marketing technique of the mutual funds.

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However this thesis research is focused on the financial performance of the ethical funds, rather than on its social impact. This study seeks to investigate the effect of the social screening on the financial returns. The relationship between SRI and positive changes in the business and environment can be suggested as a topic for the further research.

For the purpose of this research these funds were included in the ethical sample which use any type of the ethical criteria, regardless if everyone agrees that this criteria is truly ethical or not. However most of these funds are quite famous and appear in the several ethical rankings. Thus the assumption is made that these funds can be used as the good represen-tatives of the society of the socially responsible institutional investors.

2.3.3 Financial performance of ethical funds

The main question of this study is the financial performance of ethical funds. Thus, the background on the effect of the SRI approach on the performance of the mutual funds is reviewed in this chapter.

There are several approaches to the analysis of the SRI effect on the financial performance of the funds were found in the research literature. The obvious one is to analyse the per-formance of the funds that switch from the conventional investment objectives to SRI ob-jectives, and to investigate if there is a significant changes in the financial performance of the fund after the SRI principles are introduced. The risk-adjusted performance of the 4 UK funds, that switch to SRI, is analysed by Mill (2006). This study concludes that there is a positive effect of the SRI approach on the financial performance of the mutual funds oc-curs over a 4 years period from adoption of SRI. This evidence support the hypothesis that the SRI fund perform better than conventional funds.

However the comparative analysis of the ethical and non-ethical funds do not prove the significant difference in the financial performance. Mallin et al.(1995) examine the perfor-mance of the UK ethical mutual funds and compare it with the perforperfor-mance of the non-ethical funds using the Sharpe, Jensen and Treynor measures. They conclude that there is no significant difference in the performance between two samples. Late Kreander et al. (2005) perform the similar test using the same measures and additional regression analysis, on the sample of the ethical and non-ethical funds from the different countries. This test did not show the significant difference in the performance of the ethical and non-ethical funds as well.

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One of the reasons for choosing this topic for the thesis research is the disproportion be-tween the big amount of the theoretical predictions of the positive effect of the SRI on the financial performance of mutual funds and little empirical evidence which would confirm this hypothesis. As well there are some expectations that there is in fact no obvious differ-ence in financial performance between ethical and non-ethical funds, since most of the empirical results do not indicate any. Therefore the additional analysis of the management fee charged by the funds is conducted, to check if ethical and non-ethical funds are differ-ent in the compensation they ask for their services.

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3

Method and Data

3.1

Method

To answer the research questions the performance of the group of ethical funds was com-pared with the performance of the group of non-ethical funds using the matched pair analysis5. To evaluate the risk-adjusted performance the Modigliani and Modigliani (M2)

measure was chosen. The matched pair analysis is used in several other studies, that ana-lyse the performance of ethical funds. This thesis research is based on the approach sug-gested by Mallin et al. (1995), and later used by Kreander et al.(2005) to compare the risk-adjusted performance of ethical and non-ethical funds. The idea is to create two samples, one consists of the ethical funds and another consists of the non-ethical funds. The sam-ples are matched in a way that for every fund in the ethical sample there is a similar fund in the non-ethical sample. Funds can be matched on the basis of size, date when the fund is launched, investment universe or others. The reason behind the method is to make the samples comparable to eliminate the effect of specific characteristics on the performance of the ethical funds (Mallin et al., 1995). The characteristics considered in the previous studies are size and age. Many investors believe that there is a difference in performance between large and small mutual funds (Gallagher, 1988). As well, it is noticed that most of the ethical funds are relatively small. Thus to avoid the size effect, the funds in non-ethical sample should be matched in size to these in the ethical sample. Concerning the age of the fund it is obvious that non-ethical funds have a longer history than the ethical funds, which is also believed to have an effect on the performance.

Following the approach suggested in the previous studies, two samples of the mutual funds, ‘ethical’ and ‘non-ethical’6, are created. The funds were matched on the basis of size,

launch date, sector (or investment universe) and index. The data on the funds historical monthly share price was collected for the 33 months period and the historical monthly rates of return were calculated using the following formula:

(1)

5In some studies this type of analysis is also called matched samples analysis 6In this study non-ethical fund and conventional fund are synonyms

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Where is the return earned by the fund i in the month t; is the price of the share of the fund i in the month t, is the price of the share in the month t-1.

The average monthly rates of return were multiplied by 12 in order to calculate the annual-ised returns. Using the annualized returns for the funds and benchmarks the risk adjusted performance, M2 measure was calculated. Finally the risk-adjusted performance of the ethical funds was compared to the benchmark and the risk-adjusted performance of the conventional funds.

As it is discussed in the introduction section another part of the research is to investigate whether or not there is a difference in the annual management fees between ethical and conventional funds. And if yes, whether or not the management fee is linked to the per-formance. The data on the annual management fees and the initial charge were collected for every fund. The regression model is used to analyse the relationship between the man-agement fee, the performance and the ethical status of the fund.

3.1.1 Modigliani and Modigliani model

It is common to use the risk-adjusted measures to evaluate the performance of the mutual funds. This approach is used in many previous researches including Sharpe (1966) and Jen-sen (1968). There are several different measures of the risk-adjusted performance can be used. As it is discussed above for this thesis research the Modigliani and Modigliani (M2) measure is chosen. The reason for using the risk-adjusted measures is to make the per-formance of the funds comparable with benchmark and each other. The main characteris-tics of the mutual fund financial performance are the rate of return and the risk. The stan-dard deviation of the rates of return is often used as the measure of the funds’ risk. The higher rate of return is normally associated with higher risk. For this reason it is important to make a decision if the expected returns from the certain investment are appropriate for the level of risk related to this investment. The funds in the samples provide different re-turns with the different level of the risk. Thus there are funds which give better rere-turns but might be more risky, and these which show smaller returns but are less risky. It is hard to compare the funds according to the both criteria at the same time. Using the risk-adjusted measure is a way to solve this problem. This measure shows what would be the rate of

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re-turn of the certain fund if it provides the same risk as the benchmark. When all of the rates of return are adjusted to the same level of the risk it is easier to compare and conclude which fund is performing better. The M2 measure implies that the expected return on the portfolio is adjusted to the same level of risk as the benchmark by borrowing at the risk-free rate and investing in the portfolio (when need to increase the risk of the portfolio) or selling the part of the portfolio and investing at the risk free rate (when need to decrease the risk of the portfolio). Increasing the risk of the portfolio, by borrowing at the risk-free rate, leads to the increase in the portfolio return (assuming that return on the portfolio is higher than risk-free rate). Decreasing the risk of the portfolio by investing risk-free, leads to the decrease in the portfolio return (assuming that return on the portfolio is higher than risk-free rate).

The M2 measure can be calculated using the following formula:

(2)

Where is the risk-adjusted performance of the portfolio i; is the standard

devia-tion of the market portfolio; is the standard deviation of the portfolio i; is

the excess return of the fund i; is the annual risk-free rate of return. The excess return is estimated using the formula below:

(3)

where is the return on the portfolio i; is the annual risk-free rate of return.

As the proxy of the market portfolio the benchmark indices are commonly used. The risk-free rate of return is assumed to be the rate of return on the UK 1-year Treasury Bonds. According to the market data at the bbc.co.uk, on the April 2009 it equals 4.75%. In this case the choice of the risk-free rate do not affect the comparative analysis, the certain fund will show the better RAP than another fund, regardless the value of .

3.1.2 Cross section regression

As it is mentioned before for the more comprehensive analysis of the difference be-tween performance of ethical and non-ethical funds the cross-section regression model is

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used. There are two main reasons why the regression model is suggested in addition to the risk-adjusted performance analysis. First analyzing the risk-adjusted performance one might only conclude that on average ethical funds outperform (underperform/have the same per-formance) as the conventional funds. The regression analysis can show more specifically the relationship between performance and fund’s decision to invest ethically. Therefore, the regression analysis is assumed to be a good contribution to the study on the risk-adjusted performance. Second, the regression model allows to analyze the determinants of the financial performance. The emphasis is put on the relationship between the manage-ment fee and the performance.

The following regression model is chosen: (4)

Where is the risk-adjusted performance of the fund. is measured in the millions of pounds sterling. is the number of months from the launch date. is the initial charge for buying the share in the fund (in percentage). is the annual management fee charged by the fund (in percentage). is the ethical status of the fund according to the Ethical Investors UK Ranking. Finally is a random disturbance term.

The certain model is identical to the one in the Kreander et al.(2005) research. The only difference is that in Kreander et al. only 2 values are assigned to the dummy vari-able, 0 when the fund is ethical and 1 when it is non-ethical. In this research vari-able will be the rank of the ethical fund according to the Ethical Investors UK Rating. The rating approach and its application are discussed in more details below in the Data part. Kreander et al.(2005) documented the positive relationship between performance and , while the coefficient turned out to be insignificant. Nevertheless the authors men-tioned that the results were different from these obtained by other analysts. Collecting the data for the thesis research it was noticed that the initial load varies more significantly from fund to fund than the annual management fee. For 46 funds out of 58 in the sample the annual management fee is equal to 1.5%. Thus it is assumed that the higher performance might be reflected not in the higher management fee, but rather in the higher initial load. Therefore despite the results from the previous studies the coefficient is expected to be insignificant, while the coefficient is expected to be positive and significant. Since

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this thesis is primarily focused on the relationship between performance, SRI and the man-agement fee, the coefficients and are discussed very little. However it is expected that these coefficients are insignificant. These results were obtained by Kreander et al. (2005) and there are no changes in the model which would allow to anticipate differ-ent results.

3.2

Data

3.2.1 Samples

For the purpose of this research the two samples consist of the Unit Trusts and OEICs were created, one for the matched pair analysis of the risk-adjusted performance and an-other one for the cross-section regression model (Tables 1 and 2, Appendix). The samples consist almost of the same funds, however the latter one is smaller, due to the absence of the data on the Ethical Ranking for some of the funds. The exclusion of the funds from the sample is discussed in more details in the last part of this chapter.

The funds were selected from the Trustnet Financial Express Company database. This da-tabase contains the information on the 2410 Unit Trusts and OEICs. For the purpose of the research the 58 funds (29 ethical and 29 non-ethical) were selected for the analysis of the risk-adjusted performance, and 54 funds (both ethical and non-ethical) were selected for the cross-section regression. The selection process was conducted following the 3 steps:

1) Selection of the ethical funds;

2) Selection of the matched non-ethical funds; 3) Selection of the funds for the regression analysis.

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Figure 2 The data gathering procedure

Source: Made by the author

The selection process is described further in this chapter. First the gathering of data for the risk-adjusted performance analysis is discussed, later the collection of the data for the cross-section regression analysis is illustrated.

The historical prices of the funds’ shares and of the indices’ performance were collected from the Market Data sections at the Bloomberg, Google Finance websites. The share prices were collected for the first trading day of each month, measured in the UK pence.

3.2.2 Data gathering

Out of 2410 Unit Trusts and OEICs in the Trustnet Financial Express Company database 58 are focused on the Ethical/Sustainable investments. Among these only 32 were invest-ing in equity, and provide all the information relevant to this research. After data collection 3 funds were dropped, 2 of them because there were no information on the area of invest-ments and 1 because the comparable non-ethical fund was not found (Step 1, Figure 2). Using the same database the other 2352 Unit Trusts and OEICs with focuses another than Ethical/Sustainable investments were screened to match the sample of the ethical funds. After the screening process described below, another sample of 29 conventional funds was created (Step 2, Figure 2).

As it is discussed in the Method part, for the purpose of this research the funds are matched on the basis of size, age, sector and index. All the information about these

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charac-teristics is obtained from the Trustnet Financial Express Company website. The size of the funds is measured in the million pounds sterling on the March 20097. As the age the

num-ber of the months from the launch date is used. The sector is defined according to the Trustnet classification, and mainly referred to the investment universe the certain fund is operating in. The sample includes the funds from the following sectors: Global Growth, Europe Excluding UK, Europe Including UK, Asia Pacific Excluding Japan, UK Equity Income, UK Growth & Income, Active Management, UK All Companies. Respectively these funds are using the following indices to create the portfolios: FTSE World Index, MSCI The World Index, FTSE World Europe EX UK Index, FTSE World Europe Index, MSCI Ac Asia Pacific ex Japan Index, FTSE All Share, FTSE-350 Index, FTSE-100. These indices are used as the benchmarks for the risk-adjusted performance analysis.

To match the ethical funds in the sample the attempt to satisfy all the 4 criteria was made. However, if the sector and the index can be matched completely, that is not the case with the size and the age of the fund. It is almost impossible to find two funds with exactly the same size and the same launch date. Thus one of the factors had to be chosen as the prior in the selection process. In this study the size of the fund is considered to be more impor-tant than the age, since it is assumed that the small fund effect is more imporimpor-tant than the age of the fund. Thus the selection process was conducted in the following way. First of all for the certain ethical fund from the Trustnet database were selected all conventional funds operating in the same sector. Than the attempt was made to match all the three remains criteria: index, size and age. For most of the funds there was no match which would be the best according to the all three criteria. Therefore the criteria were ranked according to the importance for the research purpose. The most important was considered the index, than the size of the fund and the least was the age of the fund. Thus first of all it was important to match the funds according to the size and the index they track. After the funds were screened to find these which match the size and the index criteria, the fund with the closest launch date was selected. This procedure is illustrated on the Figure 3.

7The exact day varies from fund to fund, but it was verified that there is no significant changes in size for the estimation period. The significant change was considered the change in size more than 5%. In this case the latest information on the size of the fund was used.

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Figure 3 The selection of the non-ethical funds

Source: Made by the author

In the created samples all the fund pairs are the best matches according to at least three out of four criteria. The priorities are given to the Sector, Index and Size criteria.

One more issue is taking into consideration while screening the funds. As it is discussed in the Introduction chapter one of the key limitations to this study is to verify if the certain fund is ethical or non-ethical. While the ethical funds specify in their profiles that they fo-cus on the ethical/sustainable investments, the conventional funds not always provide in-formation to which extent they are concerned about the ethical issues. Thus some of the conventional funds might as well screen the companies included in their portfolios and avoid investing in the same industries as the ethical funds. For this reason, the main hold-ings in the portfolios of the funds were analysed as well to verify if the fund can be classi-fied as non-ethical. The priority was given to the funds which invest in non-ethical and non-sustainable industries like tobacco, gambling, oil and gas and others.

3.2.3 Data for the cross-section model and Ethical Rating

The data on the launch date, size, initial load, management fee and ethical status of the funds was collected to carry out the regression analysis. It is possible to access the funds profiles from the Trustnet website, which provide the data on the launch date, size, initial load and a management fee for all of the funds in the database. However there were no in-formation about the ethical status, namely ethical ranting of the funds on this website. Therefore some other source was used to obtain the information about Ethical Rating. Af-ter collecting the data for the cross-section regression analysis 4 ethical funds were

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ex-cluded from the study sample, because there were no information on the Ethical Rating (Step 3, Figure 2). It resulted in the total sample for the regression analysis of 54 funds. To define the variable in the regression model the Ethical Rating from the Ethical Investors company, the first finuncial adviser company that specialized on the ethical in-vestment advice was used(Ethical Investors). As well the information on the ethical status of the certain funds was verified using the EIRIS Ethical Fund Directory. EIRIS Ethical Fund Directory provide the profiles of the ethical funds in UK and explains the SRI ap-proach, used in every fund and the ethical issues each fund is particularly concerned about. Since the both sources report similar information about the ethical policy of the funds in-cluded in the sample, the proposed Etrhical Ranting is assumed to be credible and appro-priate for the research.

The ethical rating is available on the Ethical Fund Directory at the Ethical Investors web-site. Only ethical and sustainable funds from UK are included in the rating. The funds are rated in three areas Animals, Environment and Social. The animals’ issues are focused on the animal testing. The environmental issues include the exclusion of companies based on negative impacts; investing in companies that are taking positive steps to manage their pacts and others. The social category covers issues arising from company activities that im-pact on people, or society at large. Each fund is rated in these three areas as better as or worse than average, comparing to the rest of the funds. Thus each fund can be evaluated as Below Average, Average, Plus or Double Plus in every category. For the sake of the regres-sion analysis this ranking system is simplified and transformed to the numerical form. So the ranking system was given a numerical equivalent in each category (Table 1). The idea is to distinguish the ethical funds in the sample from each other and from the non-ethical funds. Therefore each fund is given the value from 0 to 12, based on the rating. The 0 val-ue is given to the non-ethical funds, which are not included in the Ethical Rating. The valval-ue 12 is given to the funds which are estimated as Double Plus in all three categories Social, Animals and Environmental. For the sake of simplicity all the categories are assumed to have the same weights in the rating. Therefore the Below Average estimate in any category gives the fund 1 point. So if the fund gets the Below Average estimation for all three cate-gories it will sum up to the total rating equal 3. Respectively the Average estimate gives the fund 2 points. So if the fund gets the Average estimation for all three categories it sums up to the total rating equal 6. Following the same approach the Plus estimate gives the fund 3 points and the Double Plus estimate gives the fund 4 points. The points received in each

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category sum up and result in the total value given to the fund for the sake of the regres-sion analysis.

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Table 1 The Ethical Rating

The position of the fund in the rating

The ethical areas

Animals Environment Social Not in the rating

(non-ethical) 0 0 0 Below Average 1 1 1 Average 2 2 2 Plus 3 3 3 Double Plus 4 4 4

Source: Ethical Fund Directory and the author’s calculations.

For example if the fund receives Average in the Environmental and the Social categories and Below Average in the Animal category, it’s total rating is 2+2+1=5.

All funds in the sample are evaluated according to this system and the obtained results are used for the regression analysis. The outcome is shown in the Table 2 in the Appendix.

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4

Empirical Results and Analysis

4.1

Characteristics of the data sample

It is discussed in the Method and Data chapter that funds in the sample are operating in the different sectors. The distribution of the funds among these sectors is illustrated on the Figure 4 below:

Figure 4 The distribution of the funds in the sample among the sectors

Source: Trustnet Financial Express Company database

For the purpose of this research two matched samples of the ethical and non-ethical funds were created. All the pairs of the matched funds are from the same sector and using the same index. As well all the funds are matched very closely according to the size criterion (Table 2). In the sample of the ethical funds the size of the largest fund is 406 million pounds and the smallest is 0.8 million pounds, the average size of the ethical fund in the sample is 86.78 million pounds. For the sample of non-ethical funds the size of the largest fund is 384.5 million pounds and the smallest is 1.5 million pounds, the average size of the fund in the sample is 84.99 million pounds.

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Table 2 The size of the funds in the sample

Ethical Funds Non-Ethical Funds Largest fund 406 million pounds 384.5 million pounds Smallest fund 0. 8 million pounds 1.5 million pounds Average size 86.78 million pounds 84.99 million pounds

Source: Trustnet a Financial Express Company database

The average size difference between two matched ethical and non-ethical funds is 7.68 mil-lions, which is only 8.8% of the average size of the ethical funds in the sample As well 19 pairs have a difference in size less than 7.68 million and 10 more than 7.68 million.

The average age of the ethical funds in the sample is 134 months, and of the non-ethical funds 144 months. The average difference in the age between two matched funds is 43 months, which is quite a lot. In the data gathering section it is discussed why the age crite-rion was given the low priority in the selection process. That is why not every fund pair in the sample consists of the best matched according to this criteria.

It is mentioned in the Data gathering part that in addition the main holdings of the conven-tional funds were analysed in order to verify if the fund can be classified as non-ethical. It was noticed that tobacco companies are often appear among the 5 largest holdings of the funds. In the collected sample 12 of the funds have the tobacco companies among the largest holdings. These funds are listed in the Table 3 together with the tobacco companies they invest in.

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Table 3. The funds which have the tobacco companies among the 5 largest holdings and the tobacco companies they invest in.

NAME Tobacco Company

1 SVM UK Alpha ITG

2 Invesco Perp Childrens ITG, BAT

3 BlackRock Global Equity ITG, BAT

4 GLG UK Growth BAT

5 JPM UK Focus ITG, BAT

6 Legg Mason UK Equity BAT

7 Aviva Inv Blue Chip Tracking BAT

8 Trojan Income ITG, BAT

9 Allianz RCM Global Equity PMInt

10 Baillie Giff British 350 BAT

11 MFM Slater Pension ITG

12 Cler Med FTSE 100 Tracker BAT

(Imperial Tobacco Group (ITG), British-American Tobacco (BAT), Phillip-Morris International (PMInt)) Source: Trustnet a Financial Express Company database

All of these funds invest more than 3% of the assets in each of the tobacco company. Most of the funds in the both ethical and non-ethical samples charge the annual manage-ment fees equal to 1.5%. The initial loads for most of the funds, both ethical and non-ethical, are equal 5%. The distribution of the annual management fees and the front loads in the both samples is illustrated in the Figures 5 and 6 below.

Figure 5 Annual Management Fees.

ETHICAL FUNDS NON-ETHICAL FUNDS

Horizontal axis: Management Fee in percentage. Vertical axis: Number of the funds Source: Trustnet Financial Express Company database

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