Can Values Based Investing Outperform the Market?

A considerable amount of research shows that companies focused on creating real value by serving the needs of the customer, employee, and society — instead of profit at all cost — perform better long term:

1. Research by Fred Reicheld of Bain Consulting concluded that ethically admirable companies have more sustained growth and are, therefore, better long-term investments. This research demonstrates the relationship between business ethics and business success; companies that seek to create value for their customers first rather than seeking profits at all costs are more profitable in the long run.

[F. Reicheld, “The Ultimate Question”. Harvard Business School Press, 2006.]

2. More evidence of ethics translating into positive financial performance can be seen in the Domini 400 Socially-Responsible Index, which has outperformed the S&P 500 by 0.73% annually over approximately 19 years. Launched in May 1990, the Domini 400 is the first benchmark index constructed using environmental, social and governance (ESG) factors. It is a widely recognized benchmark for measuring the impact of social and environmental screening on investment portfolios. The index is designed to reflect the way social investors select companies. Normally, about half the S&P 500 companies (250 stocks) are also constituents in the Domini 400. From May 1, 1990 to March 31, 2009, the Domini 400 has outperformed the S&P 500 by 0.73% annualized (7.74% compared to 7.01%).

3. The Credit Suisse Most Admired Portfolio examines the alpha-generating characteristics of a strategy based on Fortune magazine’s yearly Most Admired Companies list. Fortune has published its Top 10 list of most admired companies annually since 1983, and investing in these companies has offered a performance advantage over the S&P 100 benchmark. The strategy in question uses the past five Most Admired Companies lists (50 companies in total) to construct a current portfolio. Companies are assigned 2% of the current portfolio for each appearance in the Top 10 list over the past five years. In dollar terms, the most admired companies strategy produced over twice the return of the S&P 100 from 1983-2009. An investment of $100 in the portfolio would have grown to $2,544 versus $1,153 in the S&P 100. The strategy’s annualized return was 3.3% greater than that of the S&P 100.

4. Finally, analysts from Goldman Sachs and Deutsche Bank also contend that values based investing helps to improve performance. In the article “Goldman, Deutsche Back ‘Do-Gooder’ Funds,” it suggests that negative screening is necessary, but not sufficient for realizing the potential performance of ethical investing; negative screening must be coupled with positive screens–those that focus on companies with responsible corporate governance, for example.