8. Investigating the Long-Term Performance of Portfolios Managed with Ethical or Socially Responsible Investing Principles (Mock Up)

Introduction

Ethical or socially responsible investing (SRI) focuses on generating financial returns while promoting positive social or environmental outcomes. This case study explores the long-term performance of portfolios managed with SRI principles compared to traditional investment strategies. Students will analyze different investment approaches’ financial performance, risk profiles, and social impact.

Objectives

1. Understand the concept of ethical or socially responsible investing (SRI).
2. Analyze the financial performance of SRI portfolios compared to traditional portfolios.
3. Evaluate the risk profiles and social impacts of SRI strategies.
4. Discuss the advantages and disadvantages of integrating SRI principles into investment decisions.

Background Information

Key Concepts

• Ethical Investing: Selecting investments based on ethical guidelines, such as avoiding companies involved in harmful practices.
• Socially Responsible Investing (SRI): Incorporating environmental, social, and governance (ESG) criteria into investment decisions.
• Traditional Investing: Focusing primarily on financial returns without explicitly considering social or environmental factors.

Key Financial Metrics

• Return on Investment (ROI): A measure of the profitability of an investment, calculated as net profit divided by the initial cost of the investment.
• Standard Deviation: A measure of the volatility or risk of an investment.
• Sharpe Ratio: A measure of risk-adjusted return, calculated as the difference between the portfolio return and the risk-free rate, divided by the standard deviation.
• Beta: A measure of a portfolio’s volatility relative to the overall market.

Portfolio Analysis

Portfolio 1: Ethical/SRI Portfolio

Composition:

• 30% in renewable energy companies.
• 20% in companies with strong labour practices.
• 20% in companies with low carbon footprints.
• 20% in companies promoting diversity and inclusion.
• 10% in community development financial institutions.

Performance Metrics:

• ROI: 8% per annum.
• Standard Deviation: 10%.
• Sharpe Ratio: 0.6.
• Beta: 0.8.

Portfolio 2: Traditional Portfolio

Composition:

• 40% in large-cap technology stocks.
• 30% in large-cap financial stocks.
• 20% in blue-chip industrial companies.
• 10% in government bonds.

Performance Metrics:

• ROI: 10% per annum.
• Standard Deviation: 12%.
• Sharpe Ratio: 0.7.
• Beta: 1.0.

Portfolio 3: Balanced Portfolio (Hybrid)

Composition:

• 20% in renewable energy companies.
• 20% in companies with strong labour practices.
• 30% in large-cap technology stocks.
• 20% in blue-chip industrial companies.
• 10% in government bonds.

Performance Metrics:

• ROI: 9% per annum.
• Standard Deviation: 11%.
• Sharpe Ratio: 0.65.
• Beta: 0.9.

Case Study Analysis

Task 1: Compare Financial Performance

1. Evaluate ROI and Sharpe Ratio:

• Compare the ROI and Sharpe Ratios of the Ethical/SRI Portfolio, Traditional, and Balanced Portfolio.
• Discuss the implications of the differences in returns and risk-adjusted performance.

Task 2: Analyze Risk Profiles

1. Assess Standard Deviation and Beta:

• Compare the standard deviation and beta of the three portfolios.
• Analyze how the risk profiles differ between SRI and traditional investing approaches.

Task 3: Social Impact Assessment

1. Evaluate Social Impact:

• Discuss the social and environmental benefits of the Ethical/SRI Portfolio.
• Compare these benefits to the potential impacts of the Traditional Portfolio and Balanced Portfolio.

Task 4: Discuss Advantages and Disadvantages

1. Ethical/SRI Investing:

• Advantages: Promotes positive social change, aligns investments with personal values, potential for long-term sustainability.
• Disadvantages: Potential for lower financial returns, limited investment choices, higher research costs.

2. Traditional Investing:

• • Advantages: Focus on maximizing financial returns, broader range of investment options, lower research costs.
  • Disadvantages: Potential for negative social or environmental impacts, misalignment with personal values.

3. Balanced Investing:

• • • Advantages: Combines financial returns with positive social impact, diversified risk, moderate research costs.
    • Disadvantages: May not fully meet ethical goals, potential for moderate financial returns.

Task 5: Long-Term Performance Considerations

1. Discuss Historical Performance:

• Analyze the historical performance trends of SRI and traditional portfolios over the past decade.
• Consider the impact of market conditions, regulatory changes, and societal shifts on long-term performance.

2.  Future Outlook:

• • Evaluate the future outlook for SRI investing in terms of growth potential, emerging trends, and potential risks.
  • Compare this outlook with the expected performance of traditional investing strategies.

Conclusion

Students are expected to synthesize their analysis to provide insights into how different dividend policies affect shareholder value and firm performance. They should consider industry-specific factors influencing dividend policy decisions and discuss the trade-offs between providing consistent dividends and reinvesting earnings for growth.

Financial Statements for Analysis

Ethical/SRI Portfolio

Traditional Portfolio

Balanced Portfolio (Hybrid)