Entries by Robert Netzly

Black Friday Lightens Up

Black As Night I have a love-hate relationship with Black Friday. On one hand, the deals are great and it certainly helps with the Christmas present budget. But on the other hand, Black Friday has also become our unofficial “National Day Of Covetousness” where we bow down to the United States’ favorite idol, the Almighty […]

Performance Attribution of the First Biblically-based SRI Index

SUMMARY

A recent study by Shane Enete, CFA at the Biola University Inspire Research Institute For Biblically Responsible Investing (BRI), has shown that applying the Inspire Impact Score methodology to portfolio security selection generated alpha in a portfolio when compared to the broader, non-Inspire Impact Score screened benchmark. This finding adds new data to the debate of what effect values-based screening (Socially Responsible, Biblically Responsible, ESG, etc) has on the performance of a portfolio.

At Inspire we believe that good values and good returns are not mutually exclusive, and the findings from this study validate that belief. While screening a portfolio does not guarantee alpha generation, this study clearly shows that using the Inspire Impact Score methodology does have the potential to provide outperformance when compared to a non-screened benchmark.

ABOUT THE STUDY

For the purposes of this study, a traditional attribution analysis method was applied to the Inspire Small/Mid Cap Impact Equal Weight Index (”Index”) over a five year period. The study compared the contribution to overall returns from three variables:

1) Equal weight composition;
2) Sector bias; and,
3) Inspire Impact Score security selection methodology.

These three variables were then isolated and compared against the benchmark to determine the effect each individual variable had on overall performance.

“The results of the study found that the Inspire Impact Score methodology of security selection resulted in an annualized 4.7% outperformance compared to the non-screened benchmark.”

Performance data chart

Figure 1 – SP500

The remaining variables of sector weighting and equal weight composition had a negligible effect on the overall performance. (See Fig. 1) These findings pave the way for additional research into the underlying reasons as to why companies with higher Inspire Impact Scores provide the potential to outperform companies with lower Inspire Impact Scores, and the Biola University Inspire Research Institute for BRI is up to the task, but what is clear is that companies that are a blessing to their customers, communities, workplace and the world have the potential to outperform their peers and that investors who are seeking to create profit and impact do not necessarily need to resign themselves to substandard returns. Indeed, it is possible that they could experience above-average returns by including Inspire Impact Score screening in their investment strategy.

 

 

Performance Attribution of the First
Biblically-based SRI Index

Shane Enete, CFA
Biola University

Working Draft

Abstract

In the U.S., two of the most important investment trends over the last 10 years have been the rise of index investing and the rise of Sustainable, Responsible and Impact (SRI) investing. So, it would make sense that new indexes would emerge based on SRI principles. One such index is the new Inspire Small/Mid Cap Impact Equal Weight Index, which is the first biblically-based SRI index. This paper briefly discusses the methodology of this index and shows that its strong back-tested risk-adjusted returns (relative to its non-SRI S&P benchmark), are not due to sector bias (as one would expect), but are attributed to favorable stock selection within each industry sector. This index is likely the beginning of a wave of more sophisticated passive products that will meet the needs of niche investor populations better than the active products of the past.

I. Introduction

In the U.S., two investment trends have been dramatic over the last 10 years:

  •  the rise of index investing, and
  •  the rise of Sustainable, Responsible and Impact (SRI) investing

As of 2016, flows from active to index funds have surpassed one trillion dollars and SRI Investing has achieved $9 trillion of assets under management (see Figures 1 and 2).

So, it would make sense that these two trends would collide and new SRI indexes would emerge. One such index is the Inspire Small/Mid Cap Impact Equal Weight Index. This index has a unique faith-based construction that has performed well relative to its non-SRI S&P benchmark. This is likely the beginning of a new breed of indexes that will serve niche investors better than previous active products of the past.

Figure 1: Mauboussin, Michael, J., Dan Callahan, and Darius Majd, “Looking for the Easy Game,”Credit Suisse, 2017,
Figure 2:
U.S. SIF Foundation

II. Index Construction

Unlike most existing SRI indexes2, this index focuses on small-to-medium companies, weighting its index constituents equally3. In addition, this is the first passive SRI product that explicitly ties the construction of its index to a biblically-based worldview, in particular, a reformed, non-denominational Christian worldview that emphasizes traditional Biblical views on all environmental, social and governance issues. Although applying a Christian worldview to active investing products has been done for more than 100 years4, this is the first passive index based on “Biblically Responsible Investing” (BRI) principles to be introduced to the financial markets. The Inspire index is constructed using an Impact Scoring methodology that essentially overweights companies that are aligned with biblical values and excludes companies that are not aligned with biblical values. Companies with a high Impact score may have one or more of the following characteristics:

  • inspiring primary business activity that uplifts society
  • positive environmental policies
  • support biblical values through philanthropy
  • operate with a perceived high level of integrity

Companies that have a low Impact Score would likely be involved in the enabling of certain types of activities that are contrary to what the Bible says will enable human flourishing, such as abortion, pornography, labor abuse, non-traditional family values, and gambling.

2For example: MSCI’s KLD 400 Social Index, FTSE’s 4Good Index Series, Calvert’s Social Index, Dow Jones’Sustainability Index
3Chow et al., (2011), found a significant improvement in returns when equally-weighting an index (versus marketcap weighting)
4During the late 1800s, the Quakers and the Methodists followed investment practices that prohibited investing in companies that were involved in slavery, smuggling and conspicuous consumption

 

III. performance

i. Risk-adjusted Returns

Probably the biggest criticism of SRI investing is that  constructing a portfolio from a restricted universe of opportunities will impose too great a cost on the portfolio’s risk-adjusted returns, relative to their unrestrained counterparts. In other words, when trying to “do good,” there will be too heavy a cost on the portfolio.

When looking at the Inspire Small/Mid Cap Impact Equal Weight Index, early indications show a possible positive risk-adjusted performance benefit when using Inspire’s Impact Scoring methodology to construct their index. From 2012 to 2016, the Inspire index outperformed an equally weighted 50/50 blend of the S&P 400 and S&P 600 by over 4%, on an annualized basis, while maintaining a similar standard deviation.

This back tested performance result is not inconsistent with many academic studies over the years, which have shown that there is either a neutral or small benefit to risk-adjusted performance when adding different types of
SRI criteria to the managing of an investment product.5

5Revelli, C. and Viviani, J.-L. (2015), Stone et al. [2002],

ii. Attribution

Another significant criticism of SRI investing is that sector bias is really what drives the performance. DiBartolomeo and Kurtz [1999] demonstrated that the positive outperformance of one of the oldest SRI indexes, the Domini 400 Social index, was largely due to economic and sector exposures that are the result of the screening process itself.

It would make sense that certain sectors, like oil and gas, would naturally “screen themselves out” of most SRI indexes looking to protect the environment. So, given the possibility of sector biases embedded in SRI products, should it be assumed that any outperformance relative to a benchmark is simply due to large
“sector bets” that happen to go in the favor of the SRI index?

When conducting a performance attribution on the Inspire index relative to the S&P benchmark, there is no evidence that sector bets contributed to the outperformance.6

6Using the BHB model for attribution (Brinson, Hood, and Beebower, 1986). GICS sectors were used for the S&P benchmark; However, for the Inspire index, the sectors were first determined using The Industrial Classification Benchmark (ICB) sectors and then they were unofficially mapped to a GICS sector manually. An “Other” sector was used, which primarily represents the Real Estate sector, which was carved out of the S&P Financials sector during September of 2016. The small difference in alpha between tables 1 and 2 (4.4% vs. 4.2%) is due to rounding errors associated with the attribution methodology

IIV. Conclusion

Given the continued popularity of both passive index and SRI investing, new SRI indexes will likely proliferate during the next couple of years. The creation of the Inspire Small/Mid Cap Impact Equal Weight Index is the beginning of a wave of more sophisticated passive products that will better meet the needs of niche investor populations (e.g., faith-based investors) than the high-fee active products of the past.

references

[Bauer, Koedijk, and Otten, 2005] Bauer, Rob, Kees Koedijk, and Roger Otten (2005). “International Evidence on Ethical Mutual Fund Performance and Investment Style.” Journal of Banking and Finance , 29-7 (2005), pp. 1751-1767. (as cited in Milevsky et al., 2006).

[Brinson, Hood, and Beebower, 1986] Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. (1986). “Determinants of Portfolio Performance,” Financial Analysts Journal , vol. 42, no. 4 (July/August):39:44.

[Chow et al, 2011] Tzee-man Chow, Jason Hsu, Vitali Kalesnik, and Bryce Little (2011). “A Survey of Alternative Equity Index Strategies” FAJ, Volume 67,5, 2011

[DiBartolomeo and Kurtz, 1999] DiBartolomeo, Dan, and Lloyd Kurtz (1999). “Managing Risk Expo- sures of Socially Screened Portfolios.” Northfield Information Services. (as cited in Milevsky et al., 2006)

[Goldreyer, Ahmed, and Diltz, 1999] Goldreyer, Ahmed, and Diltz (1999). “The Performance of Socially Responsible Mutual Funds: Incorporating Sociopolitical Information in Portfolio Selection” Managerial Finance , 25-1 (1999), pp. 23-3. (as cited in Milevsky et al., 2006).

[Guerard, John B., Jr., 1997] Guerard, John B., Jr. (1997). “Is There a Cost to Being Socially Responsible in Investing?” TheJournal ofInvesting , 6-2 (1997), pp. 11-18. (as cited in Milevsky et al., 2006).

[Hamilton, Jo, and Statman, 1993] Hamilton, Sally, Hoje Jo, and Meir Statman (1993). “Doing Well While Doing Good? The Investment Performance of Socially Responsible Mutual Funds.” Financial Analysts Journal , 49(6) (1993), pp. 62-66

[Milevsky et al., 2006] Milevsky, Moshe, Andrew Aziz, Allen Goss, Jane (Thomson) Comeault and David Wheeler (2006). “Cleaning a Passive Index” Journal of Portfolio Management , Spring 2006:110-118.

[Revelli, C. and Viviani, J.-L., 2015] Revelli, C. and Viviani, J.-L. (2015). “Financial performance of socially responsible investing (SRI): what have we learned? A metaanalysis.” Business Ethics: A European Review , 24: 158:185. doi: 10.1111/beer.12076.

[Stone et. al, 2002] Stone, Bernell K., John B. Guerard, Jr., Mustafa N. Gultekin, and Greg Adams (2002). “Socially Responsible Investment Screening: Strong Evidence of No Significant Cost for Actively Managed Portfolios” Working paper, Marriott School of Finance, Brigham Young University, October 2002. (as cited in Milevsky et al., 2006).

A Biblical Argument for BRI

“A Biblical Argument for BRI” is a paper from the Inspire-Biola Research Institute for Biblically Responsible Investing written by Shane Enete, CFA.  Read the full paper below:  

A Biblical Argument for BRI

By Shane Enete, CFA

Assistant Professor of Finance, Biola University

In the beginning, God’s commandment for us is to work and watch over the land (Genesis 2:15).

While our culture has excelled at becoming more productive in our “working of the land” through modern portfolio theory and passive investing, we have gradually gotten worse at fulfilling the second part of God’s commandment, namely, to “watch over” the very land that we are working.

Christian investors can respond to this weakened ability to watch over the land by moving towards Biblically Responsible Investing (BRI).

In the beginning, “the LORD God took man and put him in the garden of Eden to work it and watch over it.” (Genesis 2:15, NLT, emphasis added) This is a Biblical framework for how investing should be. 

To “work the land” effectively means to enable it to produce fruit. 

To “watch over the land” effectively means to enable the garden to flourish in the midst of its fruit production. 

Since Christian investors do not necessarily find themselves with hands full of dirt as they work and watch over our world, does this mean this early job description from the Lord does not apply to a Christian investor today? How could working and watching over the land be done well for a Christian investor today?

The Biblical Argument For BRI

Work The Land

Over the last 400 years, a few key financial ideas have enabled an abundant working of the land.

For this paper, I am going to highlight three such financial ideas that have particularly helped us harvest fruit from the land: the jointstock company (1609), modern portfolio theory (1952), and passive investing (1990s)

The first crucial financial idea that allowed for a great increase in the fruitfulness of the land was the invention of the joint-stock company. A joint stock company is its own legal entity, which allowed investors to buy “shares of stock” in that independent company. The first Joint-Stock company was the Dutch East India Company in 1609.

Before the joint-stock company, any investor who wanted to invest in a company needed to become a partner of that company, which entailed a lot of paperwork and commitment. And if the investor wanted to sell his partnership position, more paperwork (and often lawyers) were needed to get out of the partnership.

One of the greatest features of owning stock in a joint-stock company was that the owner is free to sell that share of stock to any willing buyer without needing any kind of permission by the company.

Once the joint-stock company was created, money was pooled together more easily. This injected significant “liquidity” into the financial markets.

But, it was not until the large scale adoption of modern portfolio theory (MPT) that stock investing was moved from the halls of the rich to the living rooms of the common citizen.

MPT, first articulated by Harry Markowitz in 1952, argues that an investor should not put all of his or her eggs in one basket.

While this may seem like a simple concept, the revolutionary idea of MPT was that all investment opportunities should not be considered just individually, but also be evaluated together as a potential portfolio. Evaluating all investment opportunities in the context of a portfolio led the average risk-conscious investor to include stocks in their investment accounts, which eventually led to billions of dollars of retirement money1 being injected into the stock market.

The last powerful financial idea that I will mention, which served to further enhance the fruitfulness of the land, was the invention of “passive investing.”

Passive investing is when investor money is pooled together and then given to a computer that simply buys a “list of companies” (i.e., index). An index can represent exposure to any kind of desired business risk (e.g., oil companies, car companies, European companies).

Since the holdings of the index list are mostly stationary, the portfolio is not actively managed, and is said to be “passive.”

Bill Sharpe wrote a paper in 1991 called, “Arithmetic of Active Management” where he showed the simple math that, given the laws of arithmetic, half of all money managers will earn less than average returns (less than half when you subtract management fees).

By comparison, passive funds, which have minimal costs2 , should be expected to outperform most professional managers. This logic has consistently proven to be true by academic research. For example, one recent study showed that passive funds outperformed 76% of active mutual fund managers from 2003-20133.

Given the simplicity and cheapness of passive investments, investors have stampeded towards passive products and these passive products have led to widespread ownership of stocks by American households (55% of all U.S. households4, 66% of all 401k assets5, more than half of all U.S. public pension money are invested in stocks as of the mid-2000s).6 This increase in stock ownership means companies produce more goods and services since they have more access to capital for their business ideas.

1 Smith, Mark B., Equity Culture, Farrar, Straus and Giroux, New York, 2003 (pg. 219-220)

2 The most popular passive product, Vanguard’s S&P 500 Index has an annual fee of 0.05% vs. 1.0% for the average active fund.

3 https://www.nerdwallet.com/blog/investing/investing-data/activemutual-fund-managers-beat-market-index/

4 Gallup’s annual Economy and Finance survey, 2015

5 As of 2014, https://www.ici.org/pdf/per22-03.pdf

6 Pension and Investments 2012 annual plan sponsor survey

Watch Over The Land

As the world economy has proliferated in goods and services, there has been a trend of less and less monitoring of those goods and services. To watch over the land means to understand the impact of our goods and services on the community. Before the joint-stock company, modern portfolio theory, and passive investing, owners of businesses had a shared liability with their business – if the business acted in a way inconsistent with the owners’ values, all investors in that company were legally liable, so investors put a high value on monitoring their investments.

If we fast-forward to today, it is a much different story. Because of the limited liability of owning a stock (no stock owner can lose more than their initial investment) and the lower risk of owning a portfolio of stocks, owners of stock typically own hundreds of companies.

Managers, who receive investor money from thousands of different stock investors, are no longer working alongside their investors.

One of the most serious consequences of this trend is that Christian stock owners, who often own hundreds of companies, may not know when their owned investments engage in activities that deteriorate human flourishing, such as funding abortion clinics or pornographic products.

One of the most popular investment products, the Vanguard S&P 500 Index, with $443 billion dollars of investor money, includes many companies who are acting directly against Biblical values. eValueator estimates that 73% of the 500 companies in the fund are acting in ways not consistent with Biblical values.

Christians need to do a better job of watching over their investments and ensuring that they are not endorsing (or profiting from) certain corporate behavior, through their stock ownership claims, that help to lead culture away from Biblical values.7

So, what is a Christian to do, then? Is the only solution to disengage from passive investing, altogether?

7http://evalueator.com/ (as of 8/3/16)

Our Response

One simple solution is to move towards Biblically Responsible Investing (BRI). BRI is a movement of biblically inspired investment products that are able to combine the positive benefits modern portfolio theory and passive investing with a consciousness that these products need to be “watched” to ensure that Christian values of stewardship are being honored.

These BRI products are “watched” through their endorsing, engaging and excluding activities; they endorse companies that are acting especially consistent with biblical truth, but also engage and/or exclude companies that are not acting in ways consistent with Biblical truth.

While this type of “watching over” will always fail to be as effective as a single shared liability business investment, it is a step towards fulfilling God’s mandate to both work and watch over the land that has been entrusted to us.

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