Q&A with IFA: Expected Returns and Socially Responsible Investing


Question: Are expected returns for "socially responsible" strategies lower compared to a conventional approach?

Note: The question above was taken from DFA’s Fama/French Forum. Professors Fama and French gave this response:

“Our paper, "Disagreements, Tastes, and Asset Pricing," addresses this issue. Like all prices, asset prices are determined by supply and demand. If some investors overweight the stocks of "socially responsible" firms, they push up prices and reduce expected returns. Similarly, they push down the prices and push up the expected returns of the socially irresponsible firms they underweight. Presumably that is their goal—to reduce the cost of capital of firms they like by reducing the "good" firms' expected stock returns and to increase the cost of capital of firms they don't like by increasing the "bad" firms' expected stock returns. These changes in expected returns induce other investors to underweight the "good" firms and to overweight the "bad" firms. Socially responsible investing has not been around long enough to measure the magnitude of these effects. We can be sure, however, that if socially responsible investors have any real impact, they push down the expected return on the stocks they overweight and increase the expected return on the stocks they underweight.”

According to The Forum for Sustainable and Responsible Investment, as of year-end 2011, more than one out of every nine dollars under professional management in the U.S., or about $3.7 trillion, was invested according to SRI strategies. Is this number large enough to have the impact on prices and returns that Fama and French discuss above? We would say it is doubtful. As long as a portion of the remaining eight dollars (or about $30 trillion) is engaged in rational pricing activities, then we can safely assume that the both the securities that qualify for SRI strategies and those that do not are fairly priced.

The question of whether SRI investors are sacrificing diversification and thus taking on uncompensated risk was addressed in this article by Nobel Laureate Harry Markowitz, Mark Hebner, and Mary Brunson. Markowitz mathematically showed that once you have more than a reasonable number of securities in the portfolio (say 50), the expected volatility is only minimally decreased by adding more securities. Hebner and Brunson cited studies of historical returns data showing that SRI investors have not suffered as a result of excluding undesirable companies. Thus, it is entirely possible to do well while doing good. To learn more about IFA’s approach to socially responsible investing (including sustainability-oriented), please visit or