1. Several terms are used to describe this growing investment discipline that acknowledges the impact of the intersection of societies, economies, corporations, and financial markets, and the importance of managing the risks emanating from these entwined relationships in order to enhance long-horizon portfolio returns. The United Nations Principles for Responsible Investment (www.unpri.org) defines responsible investing as an “approach to investing that aims to incorporate environmental, social, and governance factors into investment decisions, to better manage risk and generate sustainable, long-term returns,” and the Global Sustainable Investment Alliance defines sustainable investing as “an investment approach that considers environmental, social, and governance factors in portfolio selection and management.”
2. The GSIA is composed of The European Sustainable Investment Forum (Eurosif), UK Sustainable Investment & Finance Association (UKSIF), The Forum for Sustainable & Responsible Investment (US SIF), Responsible Investment Association Australasia (RIAA), Responsible Investment Association Canada (RIA Canada), and Dutch Association of Investors for Sustainable Development (VBDO).
3. The assets of US$15.0 trillion and US$10.4 trillion invested in negative/exclusionary screening and ESG integration strategies, respectively, exceed the total US$22.9 trillion invested globally in SRI strategies because of double counting across the seven ESG-oriented investing strategies defined by GSIA: negative/exclusionary screening, positive/best-in-class screening, norms-based screening, ESG integration, sustainability themed investing, impact/community investing, and corporate engagement and shareholder action.
4. The terminology used in BNP Paribas (2017) is responsible investing, or RI, an alternate name for SRI.
5. The Pew Research Center defines the Millennial generation as those born after 1980 and the first generation to come of age in the new millennium.
6. “Headline risk” (the risk of being written up in the financial press for investing in companies with socially problematic practices or experiencing controversies) and related reputational issues are additional understandable concerns that may prompt investor managers to rationally trade off return potential for peace of mind.
7. Asness (2017) offered a transparent and balanced explanation of the classical market-equilibrium view of ESG-related investing.
8. The pure equilibrium rate-of-return argument is complicated by the presence of monopoly conditions in many sin industries, where barriers to entry are high, as noted by Fabozzi, Ma, and Oliphant (2008). The curse of social science research, including empirical finance, is that we study the one realization of history, in which observed returns are subject to multiple—and potentially impactful—shocks not taken into consideration in the modeling process. This makes it difficult to assert that empirical conclusions based on a narrow history may be a good guide for future returns. For instance, the modern return sample associated with alcohol, tobacco, and gambling companies may have been impacted by a series of lucky developments from their perspective: a trend toward deregulation and greater consumer access for the gambling industry, better-than-expected litigation outcomes related to public health and tobacco, and the emergence of a growing world economy hungry for American-style sin and consumption as the end of the 20th century approached.
9. RAFI Fundamental Index™ is Research Affiliates’ proprietary non-price-weighted index strategy that aims to deliver excess return versus the cap-weighted benchmark by using fundamental measures of company size to systematically rebalance against the market’s constantly shifting expectations.
10. These comments were made as part of the announcement of Climate Action 100+ in December 2017: https://www.top1000funds.com/news/2017/12/19/investors-launch-climate- action-100/
11. See, for example, Fama and French (2006, 2008, 2014, 2015), Novy-Marx (2013), Hou, Xue, and Zhang (2015), and Ball et al. (2015).
12. Roll (1986) argued that managers’ hubris and tendency to engage in empire building for its own sake (and their private benefit) leads to a firm’s aggressive investment, often accompanied by disappointing subsequent outcomes.
13. See, for example, Boudoukh et al. (2007) and Fama and French (2008).
14. See, for example, Sloan (1996), Hirshleifer et al. (2004), Dechow and Ge (2005), and Chan et al. (2006).
15. Krawcheck (2017) argues that “what we are only beginning to recognize is that demeaning and devaluing women is an insidious, expensive problem.” She links gender discrimination on Wall Street to increased risk taking and to the global financial crisis.
16. Collective intelligence refers to the ability of a group of individuals to perform a variety of general cognitive tasks requiring the application of acquired knowledge and skills and is similar to the concept of individual intelligence measured as IQ (intelligence quotient).
17. Dezsö and Ross (2012), Gao and Zhang (2016), and Hewlett and Yoshino (2016) have found that greater diversity is associated with higher levels of innovation, and Lee et al. (2015) pointed out the lower rate of financial controversies associated with the greater presence of women in the C-suite.
18. Credit Suisse (Dawson, Kersley, and Natella, 2016), MSCI (Eastman, 2017, and Lee et al., 2015), Peterson Institute for International Economics (Nolan, Moran, and Kotschwar, 2016), and the non-profit organization Catalyst (2013) all have found that firms whose boards have more women and who have more women in the C-suite have stronger financial performance than firms who have fewer or no women in such positions.
19. See, for example, Pathan and Faff (2013) and Hoobler et al. (2016).
20. McKinsey (Hunt, Layton, and Prince, 2015) based their analysis of financial outcomes on EBIT.
21. This is the case in several relatively well-known and frequently cited studies connecting diversity with investment returns, such as Morgan Stanley (2016) and Lee et al. (2015), which only look at returns over a handful of years.
22. See, for example, Kolhatkar (2017).
23. In related research, Viviani, Revelli, and Fall (2015) studied a short history that covers the global financial crisis, from 2006 to 2012, and concluded that companies with better social responsibility scores, including those linked to human resources, as provided by Vigeo Eiris, had lower downside risk during this period based on Value-at-Risk statistics. Once again, the sample period is short, but the focus is on risk measures in the cross-section of companies, which may be somewhat more revealing.
24. When a new equilibrium is reached years from now, we will gladly report on it in an article titled “The Diversity Dividend Is Fully Realized.” Note this process also implies the type of revaluation alpha that we have pointed out in the past (Arnott et al., 2016), which should not be extrapolated forward.
25. See Arnott, Hsu, and Moore (2005) and Arnott et al. (2013).
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