Socially responsible investments (SRI) incur higher risk than traditional portfolios and investors are failing to use SRI indices as benchmarks, according to new research from Germany’s Commerzbank.
Commerzbank says it is worrying that very few managers use a corresponding SRI benchmark for their SRI investments and that institutions, such as pension funds, are not always aware of the high risk involved.
The research is based on analysis of the Dow Jones STOXX Sustainability index, an SRI benchmark, and comparisons with the broader based, Dow Jones STOXX 600.
The main finding is that there is a 2.75% tracking error between the two indices, whilst a typical, conventional actively-managed portfolio has a 2% tracking error against the Dow Jones STOXX 600.
However, though Commerzbank acknowledges the risk level is higher than most institutional investors would typically accept in their portfolios, it says it isn’t necessarily a bad thing if incremental returns compensate for it.
Specifically, the report attempts to find out whether investors should use a broad or SRI-specific benchmark, how close an SRI manager should be to a broad benchmark and whether investors are aware of differences in existing SRI benchmarks.
Commerzbank concludes that tracking against a specially-designed benchmark could reduce the risk and make SRI more efficient. This benchmark would be based upon existing SRI benchmarks but with adjusted stock weightings.
Commerzbank believes that the tracking error in SRI is attributable to stocks rather than market themes or sector-wide developments and quantitative research can pinpoint the necessary re-weightings to reduce tracking error.