Two scholars affiliated with the University of Delhi India contend in a newly published paper that the case for ethical investing in India has sound empirical support, and that accordingly more investment funds should launch schemes that invest in such funds.
But there’s an obvious problem with the database in their study. That is: the authors compare the performance of “ethical” funds (in a sense I’ll define in a moment) with general funds and benchmark indexes through the period 2009-14 using weekly net asset valuation figures. Note the use of 2009 as the starting point in their database. This means that they have begun their timeline at a moment when markets globally had no place to go but up. A more complete case for ethical investing would have to match the performance of the two sorts of fund through both sides of a business cycle.
This is not a mere methodological quibble. Consider that the authors of the study do agree with one common objection to SRI investing. As they put it, the ethical funds do (as critics contend) take on higher risk, because of “the compromise made with respect to diversification” by divesting from various funds that violate the socially responsible guidelines. These authors then infer that the higher risk-adjusted return occurs because the extra risk is “well rewarded” in the ethical context.
This of course leaves open the possibility that, in India or elsewhere, the same extra risk will be well punished in the ethical context on the way down.
The Content of Ethics
One person’s ethical investing is another person’s missing-the-point-altogether investing. In the subcontinent’s context, much ethical investing derives its content from Shariah; that is, from the rules that Islamic principles suggest ought to be followed in adding or subtracting companies from a portfolio.
Shariah, as these authors understand it, requires exclusion of the following companies from the portfolio of investment funds:
- Advertising and media firms that generate revenues of up to 65% from the countries of the Gulf Cooperation Council;
- Newspapers, news and sports broadcasting;
- Alcohol, tobacco, pornography; gambling; related activities;
- Companies engaged in duplicating;
- Investment in financial institutions other than Islamic Banks;
- Firms dealing in meat; and finally
- Firms trading in gold and silver with cash as collateral.
Some of these exclusions may seem odd to investors in the western world, who may well have different understandings of social responsibility. For example, trading in precious metals is apparently considered unethical amongst Moslems in India because it amounts to placing a speculative bet on the direction of the economy, whereas Shariah principles require a bottom-up approach.
I don’t mean to argue theology, but that understanding of “ethical” entails a lot of premises, and if those premises are to be inserted into reasoning about financial economics, they have to bear up to empirical, secular scrutiny. Investing in gold plainly does not require speculation as ordinarily considered. It is often much more a matter of macroeconomic hedging than of speculation.
Back to Risk
Indeed, that element of Shariah, the unwillingness of such funds to engage in macroeconomic hedging, heightens my concern about the blind spot in this study. It is all focused on the way up. What about the way down? That is precisely when macroeconomic hedging of the sort that typically involves gold and silver would come in handy, is it not?
The study doesn’t address this point beyond a perfunctory final-paragraph reference to it in the context of “further research work” in which the authors hope to engage, or that they hope to encourage amongst other scholars. They say that further work along these lines might look at “performance of ethical funds and their conventional counterparts …under different business economic conditions.”
This article appeared in the December issue of the International Journal of Business Ethics in Developing Economies, and was authored by Vanita Tripathi and Varun Bhandari. Tripathi’s other recent work includes an important 2012 paper on India’s FDI and microeconomic factors.