Berkeley's Haas School's Dubious Move Into "Socially Responsible" Investing

This Tuesday's Wall Street Journal contained an article detailing the University of California, Berkeley's Haas Business School's new program to teach its MBA students about asset management. This will be done via a new, "socially responsible: fund, the $250,000 of initial capital for which was donated by Charlie and Doris Michaels. Mr. Michaels is a Haas alumnus and currently president of Sierra Global Management, to be managed by Haas students.

From the interview with Kellie McElhaney, the faculty member who is director of the Center for Responsible Business at the Haas School, we learn that the intent of the program is to teach MBA and MFE (Masters of Financial Engineering) matriculants about investing.

Just on this information alone, I have grave concerns about the direction Haas is taking business education.

In January, I wrote this post, commenting on an article in the Wall Street Journal regarding the very theme of this new Haas program, "socially responsible investing." It wasn't very pretty. Not at all.

I will cite just three passages from the Journal piece by Jon Entine, a fellow at the American Enterprise Institute, which I also cited in the January post,

"The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.

The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.

It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?"

Well, at least the kids in the new Haas program don't have such a high hurdle to clear, in order to beat the average "socially responsible" fund's returns.

Seriously, though, Entine's piece suggests that the Haas program is, to be blunt, folly. The very credentialing process by which firms are judged to be "socially responsible" looks to be pure art, and easily fooled, at that.

So how are 10 MBA and MBE students going to outwit the fraudsters who, for a living, fool professional investors on this dimension?

Then there's the "MBE" matriculants.

As I contended in my recent video post, here, the 'financial engineering' degree represents yet another step in the continuing degradation of the MBA into a purely narrow, technical degree, now far removed from the certification of general business management knowledge and capability for which it used to stand.

As Wilbur Ross hilariously commented, cited in this post, from one of his appearances on CNBC this summer,

'When someone mentions two words, financial engineering, you know it's really an attempt to underprice risk.'

Great. Now we have burgeoning degree programs designed explicitly to teach new wunderkinds how to parse, conceal and pass along mis-priced risk.

Haven't we just learned what systemic folly this is in the past two and a half months?

However, perhaps the most chilling part of the Journal article, for me, was these two passages,

"Will this experience give students the skills they need to land jobs with funds that have a social-responsibility focus?

Absolutely. It will give them a competitive advantage over students with just course work on social responsibility or just investment experience. There have been a lot more SRI funds created in recent years, and I see an increasing number of job opportunities out there. What I have yet to see are the traditional investment houses posting jobs for professionals with SRI experience. But I hope I will be able to send more knowledgeable students into the traditional Wall Street firms where they can raise social-responsibility issues from inside the companies.

Does this take corporate social responsibility to a new level in academia?

It definitely will because we'll have data. It may be negative, positive or inconclusive, but there will be data. We in corporate social responsibility are still really in the throes of proving ourselves to other academicians, and the only way we can do that is through research and data."

Reading these two passages, I don't whether to laugh, or cry.

With Entine's piece as background, the 'spread' of this disease to major institutional portfolio managers is likely to depress already-mediocre average returns, for which fund owners pay good money.

To further state that this program will 'prove' anything to anyone is laughable.

Rather than take even $1MM, ten students, dubious criteria for "socially responsibility," and actually buy and/or sell short various equities, wouldn't it be more useful to task these students to rigorous, refereed papers of the sort financial academics write, to attempt to refute research hypotheses concerning "socially responsible" investing and the performance thereof?

With only $100,000 apiece, these students won't impress anyone in the industry with their performance. Believe me, I know. It takes about $25MM before anyone pays serious attention to an investment track record.

However, financial theory is routinely advanced through the use of rigorous theory development, implementation via backtesting, and analysis of the results. Each of ten students formulating different "socially responsibility"-related hypotheses, then testing them over long periods using market data would produce more, and more convincing results, in my opinion, than the Haas' new, tiny investment laboratory.

Socially Responsible Business and Investing

Friday's Wall Street Journal featured an editorial by Jon Entine, an adjunct fellow at the American Enterprise Institute who was recently asked by the Gates Foundation for research on "socially responsible" investing.

Mr. Entine's piece is relevant to me, and this blog, for several reasons. First, it so clearly demonstrates the degree to which commonly-held perceptions about businesses can be totally in error. Second, it focuses on the question of whether 'socially responsible investing,' whatever that might be, does, in fact, provide better returns than investing that does not strive to be 'socially responsible.' Third, it also provides perspective, via one brief sentence, on how out of touch so many pundits, observers and analysts are with reality.

Because I feel it is such an important, relevant, and interesting article, I have quoted from it below at length.

"It's January 2000. You manage a philanthropy that's decided to "do well by doing good." It bowed to advocacy groups and agreed to invest its endowment in only "good" companies.....

What companies do they recommend? Well, Enron has independent directors. Krispy Kreme gives tons of money to charity. Cendant is renowned for its diversity. HealthSouth is actively involved in communities. Check, check, check, check. The list goes on: Tyco, Adelphia, WorldCom, Rite Aid, Arthur Andersen, Qwest, Global Crossing, Martha Stewart, Bristol-Myers-Squibb, Lucent, Kmart.

Of course we know what happened. Every one of those "socially responsible" supernovas flamed out or are worth a fraction of what they once sold for, victims of self-inflicted ethical wounds. The big losers have been credulous pension funds, religious groups and liberal investors who put their hearts where their heads should have been.

Bill Gates might keep this history in mind today, when he meets with the media at the World Economic Summit in Davos and responds to a screed, masquerading as an investigation, directed at the $35 billion Bill and Melinda Gates Foundation portfolio. Three weeks ago the Los Angeles Times ran a series accusing the foundation of reaping "vast financial gains" from corporations with "environmental lapses, employment discrimination, disregard for worker rights, or unethical practices" that "contravene its good works."

U.S. stocks have an aggregate capitalization of $16 trillion. With all due respect to even the Gates Foundation's billions, its funds, spread over many hundreds of stocks, have no effect on the market value of any single stock. Selling a "bad" company would have no more impact than scooping a thimble full of water out of the deep end of the pool; it goes back in the shallow end when the person on the other side of that transaction buys it.

The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.

The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.

The market has proved remarkably efficient in determining what marks a corporation as "good." Customers and investors vote on that every day. It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?

For me, this is an eye-opening piece. Particularly the Body Shop story. I had an ex-sister-in-law who swore by that firm's products- its ethical treatment of animals, quality ingredients, etc., etc. All hokum, as Mr. Entine revealed. The Calvert Group story is also incredible, is it not? Complete with their money-losing 'Social Index Fund.'

Then there's the empirical evidence from the Wharton study, which revealed that adding such an arbitrary screen as 'socially responsible' decreased returns to funds that did so.

All of this gives me great reassurance that it is, indeed, enough just to earn a consistently superior return via shrewd investing. Never mind the ulterior agendas which seek to blur the sole function of institutional equity investing, which is to earn superior returns from one's equity selections and management. Which I've happily been able to accomplish.