The Agency Cost of Investıng in Ethical Funds

Ayaydın Hacıömeroğlu H., Danışoğlu S., Güner Z. N.

International Social Innovation Research Conference, Sheffield, United Kingdom, 1 - 03 September 2020

  • Publication Type: Conference Paper / Unpublished
  • City: Sheffield
  • Country: United Kingdom
  • Middle East Technical University Affiliated: Yes


With the increased popularity of ethical funds, many studies have asked the question “Does it pay to be good?” (Barnett and Salomon, 2012)[1] and compared such investments with conventional alternatives in terms of return performance. Ethical funds have an investment mandate for either positively screening stocks that meet a threshold level of environmental, social and governance (ESG) performance, or, negatively screening stocks by avoiding any that are issued by companies operating in the so-called sin industries. Investors in ethical funds have either purely social objectives or a blended objective of generating social and financial returns simultaneously. A lesser discussed issue is whether the portfolios formed by fund managers indeed adhere to the “ethical standards” that the fund’s investors have in mind when they first choose the fund. From a finance perspective, the relationship between fund managers and investors can be viewed as an agency relationship[2] since the manager’s job is to form a portfolio that includes only those investments that satisfy the ethical and social criteria that the fund investors would impose on a portfolio of their own.

This paper proposes an adjustment to the widely used Sharpe methodology (2002)[3] for examining an ethical fund manager’s “asset allocation” versus “active management” abilities. The sample includes European and US open-end ethical mutual funds for the period between 2004 and 2019. The methodology will make it possible to assess the extent to which fund managers use social and ethical criteria in their asset allocation decisions. It will also reveal whether ethical fund investors bear an agency cost in their investments.

[1] Barnett, M.L. and Salomon, R.M., 2012. Does it pay to be really good? Addressing the shape of the relationship between social and financial performance. Strategic Management Journal, 33(11), pp.1304-1320.

[2] Allen, F., 2001. Do financial institutions matter?. The Journal of Finance, 56(4), pp.1165-1175.

[3] Sharpe, W.F., 1992. Asset allocation: Management style and performance measurement. Journal of Portfolio Management, 18(2), pp.7-19.