IntroductionThis assignment examines a long-standing debate in finance: Can Socially Responsible mutual funds (or any funds that are constructed from a constrained universe of stocks) have returns similar to portfolios that draw from all possible stocks? Theoretically, SRI (Socially Responsible Investment) funds should not be able to match or exceed the performance of unconstrained funds. If you recall the efficient frontier, it is the boundary of portfolios with the highest return for a given level of risk.Theory says that if you reduce the number of individual assets from which portfolios are constructed, that you will not be able to duplicate all the portfolios on the efficient frontier and thus it will shift down a bit. This assumes that the stocks that are screened out of SRI funds are in those portfolios on the frontier. We don't know that is in fact the case, so it becomes an empirical question - one that we decide by looking at evidence.A second argument against SRI investing is that as more money moves into the SRI space, prices of the most sought after stocks will rise, so investors will be paying a premium to obtain SRI stocks. There is a little evidence that so-called sin stocks - alcohol, gambling and tobacco - sell at a slight discount. I am not sure if it works the other way - that the most highly ranked companies in terms of sustainability sell at a premium.About the dataThe data set has two tabs: one for non-SRI mutual funds and the second for the SRI sample. The non-SRI mutual funds came from a list of best large cap equity funds that I found on the US News website. You can look at the data here ( LINK to US News Mutual Fund List (Links to an external site.)Links to an external site. ). These are highly ranked funds, but I went beyond the 186 ranked funds and added another 84, so had a list of 270 that I drew a random sample of 31 from. The only criterion I used was that the fund had to have been operating at least 10 years, so you will see returns for 1,3, 5 and 10 years in the data set. All of these funds use the S&P 500 as their primary benchmarkThe SRI mutual funds came from a list on the Charles Schwab website ( LINK to SRI list here (Links to an external site.)Links to an external site. ). I took all the equity mutual funds, so this group is a little different than the non-SRI funds which are all large cap (big company) mutual funds. I did not include any ETFs (Exchange Traded Funds). I used two criteria to select a sample of 31 mutual funds from this list. Again, the fund had to have been operating at least 10 years, so you will see returns for 1,3, 5 and 10 years in the data set. The second criterion, was that I selected from the top half of 10-year performers to try to level the playing field to the US News highly ranked funds.I think looking at better performing funds is okay, because we want to know if it is possible for SRI funds to out-perform non-SRI funds. The question isn't whether any randomly selected SRI fund will out-perform. The other way this experiment could have been designed is to test whether the SRI funds out-perform their benchmarks, or what proportion of SRI funds out-perform their benchmarks compared to what proportion of non-SRI funds out-perform their benchmarks. The SRI funds have a variety of benchmarks. Some use the S&P 500, others the Russell 1000, 2000, 3000 and so on. Each fund's benchmark is listed in the data set.Do SRI Mutual Funds Underperform?Assignment: Using the data provided complete a hypothesis test or tests that address this question: Do SRI Mutual Funds Underperform non-SRI Mutual Funds?You can design the experiment anyway you'd like. Some of the decisions you will have to make include:
Choosing which returns to compare,1 year, 3 year, etc.Choosing an alpha-levelDeciding whether all the SRI funds should be used or only a subset of large cap funds.Choosing the correct test statistic.What to submitWrite a report that describes how you did your test(s) and give a rationale for the choices you made. Be sure to include the basic statistics of the data you sued (mean, standard deviation) and your test statistic and critical value. in a sentence explain how you chose the test you did, Z-score, Student t, etc.
Finally, comment on your findings and spend a paragraph or two discussing whether they match current thinking about SRI mutual fund performance. Do you think SRI performance can match that of unconstrained portfolios?I would think you should be able to fit this into two pages of text (1.5 line spacing) and several pages of supporting numerical appendices.