CHAPTER 1 ABSTRACT

Pakistani Socially Responsible

Funds: Performance, Risk and
Screening Intensity
Hamad Ullah
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CHAPTER 1 ABSTRACT

Contents
List of abbreviations: .................................................................................................................................... 1
Abstract ......................................................................................................................................................... 1
Introduction .................................................................................................................................................. 3
Literature review........................................................................................................................................... 6
Methodology............................................................................................................................................... 10
Methods .................................................................................................................................................. 10
Data collection ........................................................................................................................................ 10
Analysis /Models ..................................................................................................................................... 11
Conclusion ................................................................................................................................................... 12
Bibliography ................................................................................................................................................ 13

List of abbreviations:
Socially Responsible Investment (SRI)

Corporate Social Responsibility (CSR)

Mutual Funds Association of Pakistan (MUFAP)

Cash Settlement Price (CSP)

Capital Asset Pricing Model (CAPM)

1
CHAPTER 1 ABSTRACT

Abstract
Socially responsible investment refers to a practice of investment with ethical, religious, social or
other normative preferences into investment decision. In Pakistan this area has not yet identified,
which I will introduced in this research study. In this research I will analyses the data of ten
mutual funds five conventional and five SRI funds for five years 2014-18. I will use two models
for analysis of mutual funds CAPM and Carhart’s (1997) four-factor model. In many countries
such study has been conducted by many researchers but in Pakistan which is a third world
country so, the results would be different from the previous researches due to the reason, general
public do not have exposure of such practices while in developed countries general public are
aware of such opportunities. This study will get attention of academic as a potential area, as well
as the audience will get an idea about SRI mutual funds and its performance in a country like
Pakistan.

2
CHAPTER 3 INTRODUCTION
Introduction
Socially Responsible Investment (SRI) is an
investment approach that includes investors’
ethical, religious, social or other normative
preferences into the investment decision. For
many investors, by far the most convenient
way of investing in this way is to buy into an
SRI managed fund. SRI equity funds may
include or exclude stocks from their
portfolio holdings depending on a firm’s
behavior or involvement in particular
activities or industries. A company’s stock
may be excluded from the portfolio if the
company is involved in undesirable business
activities, for example, alcohol production
or unnecessary deforestation. Similarly, a
stock may be included if the company
possesses a certain attribute –for example, it
has progressive hiring practices or produces
renewable energy. These mechanisms are
known as negative and positive screening,
respectively. Some SRI funds implement a
‘best of sectors’ approach where portfolios
are built from a representative cross section
of companies that are deemed the best
socially responsible performers within each
of their respective industries. SRI funds are
now available in many countries around the
world, here in Pakistan the concept has not
yet been introduced and but there are some
mutual funds, managed by certified fund
managers. In this research I will investigate
performance and risk of Socially
Responsible Investment equity funds in the
Pakistani market and will screen the
companies’ stock to find the difference
between SRI’ funds and conventional funds.
I will also investigate whether the style of
SRI funds is different in terms of loadings
3
onto the size, value and momentum risk
factors. As part of an important extension to
prior research into SRI funds, I will examine
differences in screening practices within the
SRI sample. In particular, I will examine
whether the number of negative or positive
screens SRI funds impose impacts their risks
and returns. I will also investigate the effect
of the funds’ overall stringency of screening
(i.e. how many screens in total the funds
impose on their portfolios) and whether
screening for particular issues, such as
tobacco, alcohol or environment, impacts
fund performance and risk. The Pakistani
equity market has considerably fewer listed
Securities than the US market, and is
dominated by large resource stocks. This
means that, compared to the US and Europe,
Pakistani SRI Fund managers have fewer
stocks to choose from when forming their
portfolios. This raises a question that, the
performance of the Pakistani SRI funds
would be different than US and Europe and
that is why, I going to find out the
performance, screening and risk of the
Pakistani mutual funds held by ethical
investors. Here another question arise that
what is mean by ethical investment, Ethical
investment is also known as sustainable
investment and socially responsible
investment (SRI). The term describes an
investment process that incorporates
environmental and social factors when
selecting investments, in addition to the
objective of achieving a competitive
financial return (Autralianethical). Now we
have a clear idea that what is the main
objective of SRI funds. I will carry out this
CHAPTER 3 INTRODUCTION

research in the context of Pakistan but here some financial intuitions. I will use
in Pakistan the concept is new so there is no secondary data from source of Mutual
organized market, in Pakistan mutual funds Funds Association
are most probably is managed by banks and
of Pakistan (MUFAP)1. Through this source we will identify SRI mutual funds and will screen
them. In my research I will use different models like:

Rpt = ap + bpRMRFt + ept (1)

Where rpt is the excess return on portfolio p in month t,and RMRFt is the portfolio value-
weighted.

We also calculate as using Carhart’s (1997) four-factor model as follows:

Rpt = ap + bpRMRFt + spSMBt + hpHMLt + upUMDt + ept (2)

Where rpt is the excess return on portfolio p in month t. RMRFt is the excess return on the
market, SMBt is the return on the mimicking size portfolio, HMLt is the return on the mimicking
book-to-market portfolio, and UMDt is the return on the mimicking momentum factor.

Different author have used these models before for screening and performance and risk like in
Australian context there is an author who have used such models. With that study the Author did
not found significant difference between return on SRI and conventional funds (Humphrey,
2011). While the above studies investigate SRI funds as a group, recent studies have examined
differences between SRI funds, and the impact these differences have on performance and risk.
SRI funds exhibit significant variation in the way in which their SRI screens and criteria are
implemented. For instance some funds focus predominantly on environmental issues while
others are mainly concerned with reflecting ethical or religious values. There are still other funds
those apply a number of different non-financial criteria linked to a variety of SRI issues. This
means that there is substantial heterogeneity in how many and what type of screens SRI funds
impose. As other researchers has also discussed this issue. Socially responsible investment (SRI)
funds are a special market segment of the asset management industry. Although this market
segment is still relatively small it is fast growing in many countries. There are also an increasing
number of banks, asset management companies, investment advisors and rating agencies that are
specialized in this field of business. Therefore the economic performance of these specialized
investment funds is of interest to the investors and the investment companies. The main
objectives are to examine and cover previous researches gaps. This research has the following:

1
Mutual Funds Association of Pakistan is the trade body duly licensed by the Government of
Pakistan for the mutual fund industry in Pakistan. All Asset Management Companies (AMCs)
and Investment Advisory ( IAs ) licensed by SECP to launch Mutual Funds and perform
Investment Advisory Services are required under NBFC Rules 2008 to become Members of
MUFAP.( http://mufap.com.pk/pdf/WRMF.pdf)
4
CHAPTER 3 INTRODUCTION

1) To introduce ethical investment practices in Pakistan.

2) To examine the performance of mutual funds in a third world country like Pakistan.
3) There are some risk minimization techniques through investment in mutual funds that
should also be introduced.

4) To understand the behavior of mutual funds in Pakistani context.

5) To clear the perception of conventional investors regarding ethical investment.
6) There is a wrong perception of investors regarding the return from mutual funds, I will
try to explain this issue as well
7) Get the attention of academics to such potential area, which can play a very important
role in the development of economy of Pakistan.
8) In Pakistani context I will also cover the previous researches gaps that are relevant to my
topic.

The above the main reasons which brought my attention to this area, in Pakistan this issue has
not been discussed before in the academics.

5
CHAPTER 3 LITRATURE REVIEW

Literature review
The aim of this literature survey is to give a short overview of the methods and major results of
earlier studies on performance measurement of investments in socially screened equities. The
review concentrates on studies on SRI investment, performance, screening and risk by studying
mutual funds in Pakistani context. The major question of the studies on the performance of SRI
investment funds (mutual funds) is whether these funds perform better or worse than traditional
investment funds that have no restricted investment universe. SRI investment funds use a set of
social, ethical and environmental criteria to select equities. These criteria are either used to
choose specific stocks out of the investment universe (positive criteria) or to delete specific
stocks (negative criteria). Investors can expect to lose nothing by investing in socially
responsible mutual funds; social responsibility factors have no one expected stock returns or
companies' cost of capital (Sally Hamilton, 1993). This shows that there is no significant
difference while investing in SRI mutual funds and conventional funds. Several studies on the
performance of SRI investments apply a so called matching approach. They compare the
performance of SRI and non-SRI investment funds which otherwise have similar characteristics
e.g. concerning investment universe, fund size or fund age. The aim of this approach is to
consider appropriately management and transaction costs when comparing the performance.
Important studies using a matching approach are (Mallin, 1995), who analyze British investment
funds. Here I will also discuss Socially Responsible Investment (SRI) in private equity. Socially
responsible investment is more common among larger institutional investors and those investors
expecting greater Risk-adjusted returns from such investments (Cumming, 2007). This shows
that the performance of SRI funds are greater or similar to the conventional funds, which is
similar the (Mallin C. A., 1995). There is anothor author who have discussed SRI mutual funds
and conventional investment, Importance of financial returns; The notion of socially responsible
investors being willing to sacrifice or place less emphasis on financial return than less serious
socially responsible investors is something that may well be present in a small number of
hardcore socially responsible investors with stringent principles but may not be so prevalent
among less committed socially responsible investors who are willing to apply their principles
more loosely Therefore, this does not eliminate the possibility of there being a mechanism
whereby socially responsible investors judge return on social, environmental, and financial
outcomes in comparison to conventional investors who judge return on outcome alone
(McLachlan, 2004). This clear also that financial return from socially responsible investment
(SRI) funds is different in the context of judging from conventional funds, as well as the
perception of conventional investors is different from ethical investors, because they do not
judge return on social and environmental basis. As long as fund companies can profit from
designing their SRI schemes to fit certain sub-groupings with special interests, cultural
understandings or ideologies, the differences between different camps are unlikely to go away.
Despite the growing pragmatism reflected in the new terminology, the interviews revealed that
‘ethical investment’ is nonetheless still regarded as a relevant term today, deeply rooted in

6
CHAPTER 3 LITRATURE REVIEW

individual ethics and designed to respond to the ‘niche’ needs of religious investors, charities and
ethically-minded retail investors (Sandberg, 2009). There is a similarity between (McLachlan,
2004) and (Sandberg, 2009) which explain that ethical investors do keep some things in mind
like religion, society and environment etc but there are some other factors as well. Perhaps the
most common criticism of socially responsible investment funds is that imposing non-financial
screens restricts investment opportunities, reduces diversification efficiencies and thereby
adversely impacts performance. So here I am going to discuss the screening intensity,
Performance and risk of SRI funds in Pakistani context which is discussed by other authors
before, the point of including the above literature is that to give an idea to the reader about the
concept and main difference of SRI funds and conventional funds. Now I would include some
literature about the main area of my research, first, I what is screening of funds? Ethical
Screening provides information and guidance to investors to enable them to manage
their money according to their principles2. There is an author who discussed is US context. They
do not find evidence of a linear relation between screening intensity and the return of SRI funds.
However, they do find evidence of a significant curvilinear relationship between screening
intensity and performance – screening intensity first erodes and then enhances SRI fund
performance. Barnett and Salomon (2006) propose that their results reconcile stakeholder theory
and portfolio theory. They argue that funds with low levels of screening intensity have an
investment opportunity set similar to conventional funds. These funds’ portfolios are sufficiently
diversified and performance is effectively maximized within the traditional mean–variance
framework. By contrast, funds with stringent screening processes select from an investment pool
of companies that have high socially responsible standards. These companies are expected to
have higher performance due to their positive stakeholder relationships. However, the
performance of funds which apply middle-level screening intensities are expected to suffer
because these funds do not hold a mean-variant efficient portfolio but also do not screen
stringently enough to hold only firms with the best CSP. Therefore, performance is expected to
decrease initially as the screen- ing process intensifies because the benefits of diversification are
lost, but then increase as the benefits of positive stakeholder relationships begin to take effect. BS
only consider the impact of screening intensity on performance and do not consider whether
screening intensity also has an effect on the risk of SRI funds. Osthoff et al.( 2007) examine
some results from their research, investors can earn remarkable high abnormal returns by
implementing the positive screening approach or the best-in-class screening approach, but not
the negative screening approach, the best-in-class approach typically leads to the highest alphas
(up to about 8.7% per year), the best-in-class screening approach works best when investors use
a combination of several SRI screens at the same time and restrict themselves to stocks with
extreme SRI ratings, the alphas stay significant even after taking into account reasonable
transaction costs. An increasing number of investors incorporate SRI screens into their
investment decisions. This raises the question of how SRI screening affects the financial
performance of these portfolios,which is answered by (Osthoff, 2007). Another question arise

2
https://www.ethicalscreening.co.uk/

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CHAPTER 3 LITRATURE REVIEW

that what is best-in-class screening approach? According to a website ROBECO 3, The best-in-
class approach to Sustainability Investing means investing in companies that are leaders in their
sector in terms of meeting environmental, social and governance criteria. An investor who
follows the best-in-class principle does not exclude sectors or industries, such as tobacco or
mining, but instead invests in the companies that make the most effort to meet the
environmental, social and governance criteria that are relevant for their respective industries.
These researches show that there is no significant difference in the performance of SRI funds and
conventional funds but SRI funds do not earn statistically significant return, as one of the
researcher have discussed this issue as well. Most of investor may get disappointed by doing
well, investing in SRI funds and making a world a better place, who hope to do well by doing
good, investors might also be disappointed who hope low return from SRI funds in trade-off of
changing the world (Sally Hamilton, 1993). Often socially responsible investors express the
impetus to manage their money under social criteria as a desire for an "integration of money into
one's self and into the self one wish to become." An institution may strive for consistency
between its mission and the way it achieves that mission. In both instances, this motivation
comes from within (Sally Hamilton, 1993). This explains that investing in socially responsible
funds, every investor do not have the same the same perceptions, some might have ethical
views or some might want to express impetus to manage their money under social criteria, this
statement reveals that qualitative work is also required on this issue, but I am not going to cover
that part. There are some authors who have discussed the risk factor of socially responsible
mutual funds. There is the significantly negative relation between screening intensity and β, the
fund’s level of systematic risk, which suggests that an increase in the number of SRI screens is
associated with SRI funds tending to hold a greater proportion of stocks with lower βs and is
consistent with our previous finding of a significant negative relation between screening intensity
and total risk, but not idiosyncratic risk (Lee et al., 2010). These evidences have shown us
different prospects of socially responsible mutual funds versus conventional funds but where my
research would be, there are some research gapes in the researches that we have discussed just
like, A simple trading strategy based on this publicly available information leads to high
abnormal returns. This immediately raises the question of where this extra profit stems from.
Does it result from a temporary mispricing in the market or does it compensate for an additional
risk factor? Answering this question seems to be a promising avenue for future research
(Osthoff, 2007). This also justifies my research issue, in which I am going to cover these factors
as well. There are very important factor in my research question, which are performance and
screening intensity of socially responsible mutual funds that I will compare with conventional
funds. So, I also include some literature about these factors. Screening intensity is defined as the
number of screens that an SRI fund utilizes when deciding on companies to invest in. The

3
Robeco is an international asset manager offering an extensive range of active investments,
from equities to bonds. Research lies at the heart of everything we do, with a ‘pioneering but
cautious’ approach that has been in our DNA since our foundation in Rotterdam in 1929.
https://www.robeco.com/uk/key-strengths/sustainability-investing/glossary/best-in-class.html

8
CHAPTER 3 LITRATURE REVIEW

findings of a research show that there is no effect of screening intensity has on raw (unadjusted)
performance if use a model based on Carhart,(1997), performance is reduced by 70 basis points
for each additional screen imposed by the fund (Lee et al, 2010). This shows that there is no
significant relationship between screening intensity performance, if four factors model is used so
that reduces the performance which shows a negative correlation between screening intensity and
performance of mutual funds. There appears to be no significant relation between a fund’s
idiosyncratic risk and screening intensity (Lee, 2010). Investors can increase their performance
by following a simple trading strategy based on SRI ratings: Buy stocks with high SRI ratings
and sell stocks with low SRI ratings. Overall, results suggest that past SRI ratings are valuable
information for investors (Osthoff, 2007). There is similarity in between Lee et al,(2010) and
Osthoff, ( 2007) both of them are with the conclusion that there is no significant relationship
screening intensity and performance of SRI mutual funds. Now I will include some litrature
about SRI based mutual funds and conventional funds. No evidence has been found linking adoption
of SRI with a change for better or worse in mean risk-adjusted return (Mill, 2006). This statement prove
my four factor model which I will use because I observed that in some literature states that the
performance of SRI mutual funds and conventional funds have no significant difference but the expected
return is different which would explained with the help of four factors model (Carhart, 1997). The market
condition of SRI actually perpetuates cultural and ideological differences and differences in interest. As
long as fund companies can profit from designing their SRI schemes to fit certain sub-groupings with
special interests, cultural understandings or ideologies, the differences between different camps are
unlikely to go away (Sandberg, 2009). This gave us a hint that the main difference in SRI funds and
conventional funds is that while investing in SRI funds investors also special interests, cultural
understandings or ideologies which effects their decisions.

9
CHAPTER 4 METHODOLOGY

Methodology
In literature review I found that there are some previous research gaps which I address in the
literature review so, those gaps should be covered and I will contribute my research to the
existing body of knowledge, which justifies that my research is basic. In this research I will
examine the performance of mutual funds and the performance can be measured in number this
clear the fact that my research will be quantitative research. In this research I will examine and
will study the relationship of performance and screening intensity and as well as will study to
compare the performance of SRI mutual funds and conventional funds so, my research will be
co-relational research.

Methods
In this research I will include all mutual funds in Pakistan. These funds are mostly managed by
banks and asset managers. The population will include both type of funds conventional and SRI
funds. In Pakistan there is no such organization that recognizes SRI mutual funds. In this
research I will differentiate conventional and SRI mutual funds. I will use five years data from
2014-18, of both funds. The analysis will definitely be time-series. In my research I will use the
data of ten mutual funds five SRI funds and five conventional funds. In Pakistan the numbers of
SRI mutual funds are very limited that is why I choose only five from each group. I will do
probability sampling with random technique because my sample is homogenous.

Data collection
In this research I will use secondary data which is already available on MUFAP 4 website.
Mutual funds performance can be examined from its time series data which is already available,
then someone can draw conclusions on that issue so, this is the reason I will use secondary data
in my research.

4
Mutual Funds Association of Pakistan is the trade body duly licensed by the Government of
Pakistan for the mutual fund industry in Pakistan. All Asset Management Companies (AMCs)
and Investment Advisory ( IAs ) licensed by SECP to launch Mutual Funds and perform
Investment Advisory Services are required under NBFC Rules 2008 to become Members of
MUFAP.( http://mufap.com.pk/pdf/WRMF.pdf)

10
CHAPTER 5 ANALYSIS AND CONCLUSION

Analysis /Models
In this research I will use two models for analysis

CAPMi

Rpt = ap + bpRMRFt + ept (1)

Where rpt is the excess return on portfolio p in month t, and RMRFt is the portfolio value-
weighted.

Carhart,( 1997)ii the four factor model is commonly used as an active management and mutual
fund evaluation model.

Rpt = ap + bpRMRFt + spSMBt + hpHMLt + upUMDt + ept (2)

Where rpt is the excess return on portfolio p in month t. RMRFt is the excess return on the
market, SMBt is the return on the mimicking size portfolio, HMLt is the return on the mimicking
book-to-market portfolio, and UMDt is the return on the mimicking momentum factor.

These are the two most commonly used methods to adjust a mutual fund’s returns for risk. So, in
my research I will do analysis with these two models as discussed above.

My analysis will be based on time-series data; here I cannot use cross-sectional data, the reason
is that screening and examining the performance of mutual funds can measured only through
time-series data because I will analyze the historical data then I will draw my conclusion.

The limitation of this study is that in Pakistan general public is not involved in such investment
practices, as well as Pakistani economy is informal so, it would be so hard for me to draw the
attention of general public and academics as well. Here is Pakistan general public is not aware of
such opportunities and that is why they do not get involved in such practices which is the main
reason the limitation of my study.

Many researchers have conducted such study but that was in developed countries, in country
like Pakistan whose economy big part of economy is grey (informal-economy5), such study has
never been conducted and that is the interesting facts of this research which will enables me to
bring new angles in this area.

5
The part of an economy that is neither taxed nor monitored by any form of government.
https://en.wikipedia.org/wiki/Informal_economy

11
CHAPTER 5 ANALYSIS AND CONCLUSION

Conclusion
In this research I will differentiate SRI and conventional funds in Pakistani context and will
screen them and will draw my inferences to give the audience an idea about the performance and
screening intensity of SRI mutual funds, which is not yet been introduced. In this research my
main focus would be on risk and return of SRI and conventional funds, on the basis of that
analysis I will present my findings that how SRI funds perform in an informal economy. I will
also find the co-relation between performance and screening intensity, as well as risk and
screening intensity which will help to address the main issue and will also help me in drawing
academics attention.

12
CHAPTER 6 REFERENCES

Bibliography
(n.d.).

Australianethical. (n.d.).

Barnett, M. L. (2006). The curvilinear relationship between social responsibility and financial
performance. Strategic management journal , 27(11), 1101-1122.

Carhart, M. M. (1997). On persistence in mutual fund performance.,. The Journal of finance , 52(1), 57-
82.

Cumming, D. &. ( 2007). Socially responsible institutional investment in private equity. Journal of
Business Ethics , 75(4), 395-416.

Humphrey, J. E. (2011). Australian Socially Responsible Funds:. Journal of Business Ethics , 17.

Lee, D. D. (2010). Socially responsible investment fund performance: the impact of screening intensity.
Accounting & Finance, , 50(2), 351-370.

Mallin, C. A. (1995). The financial performance of ethical investment f unds. Journal of Business Finance
& Accounting, , 22(4), 483-496.

McLachlan, J. &. ( 2004). A comparison of socially responsible and conventional investors. Journal of
Business Ethics , , 52(1), 11-25.

Mill, G. A. ( 2006). The financial performance of a socially responsible investment over time and a
possible link with corporate social responsibility. Journal of Business Ethics , 63(2), 131.

Osthoff, P. C. ( 2007). The Effect of Socially Responsible Investing on Portfolio Performance. European
Financial Management, , Vol. 13, No. 5, pp. 908-922.

Sally Hamilton, H. J. (1993).

Sandberg, J. J. (2009). The heterogeneity of socially responsible investment. Journal of Business Ethics ,
87(4), 519.

screening, E. (n.d.). Ethical screening . https://www.ethicalscreening.co.uk/ .

13
CHAPTER 6 REFERENCES

i
The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk
and expected return for assets, particularly stocks. CAPM is widely used throughout finance for
pricing risky securities and generating expected returns for assets given the risk of those assets
and cost of capital. https://www.investopedia.com/terms/c/capm.asp
ii
The four factor model is commonly used as an active management and mutual fund evaluation
model. https://en.wikipedia.org/wiki/Carhart_four-factor_model

14