The effect of business cycle, market return and momentum on financial performance of socially responsible investing mutual funds

Abstract

Purpose

This study examines the effect of business cycle, market return and momentum on the financial performance of socially responsible investing (SRI) mutual funds using data from two complete business cycles as defined by the National Bureau of Economic Research (NBER).

Design/methodology/approach

A “fund of funds” approach is used to identify the extent to which SRI financial performance is affected by the macroeconomic climate. The Fama-French Three-Factor model and the Carhart four-factor model are used to bring the results into alignment with commonly used finance methodologies.

Findings

The results indicate that SRI tends to preserve value during economic contraction more than it adds value during economic expansion. Market return is important during both expansion and contraction, while momentum is important only during expansion.

Research limitations/implications

These findings suggest that double screening, for both financial and social performance, enables portfolio managers of SRI funds to have insight into those companies that are particularly vulnerable during times of economic contraction.

Practical implications

These results bring added clarity to the mixed findings found by previous researchers examining the relationship between corporate social performance (CSP) and financial performance.

Social implications

This study reinforces the idea that the financial performance of companies with high ethical standards is comparable to the financial performance of the market as a whole during times of economic expansion and superior to the market as a whole during times of economic contraction.

Originality/value

Business cycle analysis, along with the Fama-French Three-Factor model and the Carhart four-factor model, brings SRI research more into the realm of conventional financial analysis than previous studies.

Citation

Paul, K. (2017), "The effect of business cycle, market return and momentum on financial performance of socially responsible investing mutual funds", Social Responsibility Journal, Vol. 13 No. 3, pp. 513-528. https://doi.org/10.1108/SRJ-09-2016-0154