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The old performance myth – exploded

performance

A little while ago I read an article which looked at detailed performance information comparing investment returns from the wider market with and without fossil fuel companies. Now, if the figures were only compared over the last year or so I think anyone could have predicted the results – it’s a loss for the fossil fuel companies. But the analysis goes back 5 years and the bulk of this time the fossil fuel companies were riding very high. Therefore, to see the figures conclusively prove that not holding fossil fuel companies was a financially good thing was a bit of a surprise to me.I have never believed that holding fossil fuels would necessarily have added any extra performance but I wouldn’t have put money on the fossil fuel companies actually dragging performance.

Now, this is all very interesting if one is focussed just on fossil fuels but I believe that it is important to look at the big picture. By big picture, I mean the old, old, old lie that investing ethically will produce lower returns. This ridiculous lie is based on the following so-called ‘sensible’ principles:

• Investing ethically means that many companies will not be available for investment

• If a manager has a smaller pool of shares to choose from, it will limit the opportunities to pick the best performing companies

• If a manager can’t have the best performing companies, then the overall return will be reduced.

At a very simplistic level I would have to agree that the above logical thought processes makes sense. Where the proponents of the old lie are really disingenuous though is by making some unfounded and illogical assumptions to come to their “ethical investment doesn’t perform” argument. The illogical assumptions are:

• The companies that are ‘knocked out’ by applying ethical criteria are all really good companies to invest in

• That any manager has the freedom to invest in any company. The reality is that manager don’t have that freedom at all. They are restricted by the investment house style, research availability and just good old fashioned lack of time to look at every possible company.

• That all fund managers are good fund managers!

The two big errors are the last two points because they actually prove that that their own logic guarantees that non-ethical portfolios underperform too. If narrowing down the investment universe DOES actually produce lower returns, then ALL mainstream non-ethical portfolios must underperform. It is impossible for any fund manager to know everything there is to know about every single company that they can invest in. Therefore, there must be some companies that fund managers exclude from their universe for no other reason than they haven’t look at them. This randomness is no different to the random exclusions of companies caused by applying ethical criteria.

The last bullet point is one of the biggest incorrect assumptions to make. The success of Index/Passive funds is clear evidence that a high percentage of active stock picking managers do not do a very good job. In this case, whether or not these managers have access to the whole range of stocks or a reduced number of stocks won’t make any difference – not being a very good manager is more of a danger to performance than anything else. And this works for ethical and non-ethical fund managers.

In summary then, let’s once and for all put an end to the stupidity of perpetuating the old lie that investing ethically will produce lower returns. The only logic to this claim is that ethical fund managers have less stocks to pick from – that’s it. This is a spurious claim but if it were true then every non-ethical manager would be in the same situation so we get back to an even playing field. In other words, it makes no difference at all. Bad managers, not good ethics, hurt investment returns.

http://goo.gl/qj4QiO


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