Cortez et al. five-factor model

The Swedish globally investing SRI funds show a statistically higher exposure to low book to market companies, i.e. growth companies. The same conclusion is drawn for the US funds, where it is statistically significant that SRI funds to a higher degree invest in growth stocks. Overall, a majority of the mutual funds demonstrate a tendency of favoring growth companies. The findings are contradictive to Otten et al. (2002) and Renneboog (2008). Bauer et al. found varying results of both growth and value oriented stocks. Bauer et al. (2005) states that “a possible reason for ethical funds being more exposed to growth stocks is that the traditional value sectors such as chemical, energy and basic industries often bear high environmental risk.”

For a majority of the fund portfolios is the difference in exposure to the momentum effect insignificant, which is in line with Otten et al. (2002), Bauer et al. (2007) and Renneboog et al.

(2008). The Danish SRI funds are an exception, where a higher exposure to the momentum effect is identified for the SRI funds.

Table 7.5: Cortez et al. five-factor model

Mutual funds with a global investment universe

The adjusted R² increases for all regressions, which supports the expectation of the five-factor model being superior at explaining the mutual fund returns. Furthermore, a majority of the local factor coefficients are significant, which is an indication that the home bias phenomena actually exist. There are robust results with significance on the 1 % level indicating that the mutual funds in Norway, which claim to invest globally, actually prefer to invest in their own home market. The analysis of the Danish mutual funds shows similar results. By observing the local factor loadings, it is apparent that the Danish mutual funds are significantly exposed to local companies.

Furthermore, the Swedish global funds exhibit positive local factor coefficients, indicating that the

portfolio holdings are tilted towards their home market. However, these results are statistically insignificant.

Mutual funds with a regional investment universe

Also, the adjusted R² increases for the mutual funds with a regional investment scope and the Cortez five-factor model is considered to have superior explanatory power.

As expected, the Swedish and Norwegian mutual funds that invest in the Scandinavian area are exposed to the local factor. Furthermore, it is statistically proven that the Swedish and Norwegian ethical portfolios have a higher exposure to local stocks than their conventional counterparts.

Conversely, the local factor coefficient is insignificant for the ethical US mutual fund portfolio, while it is significant on a 10 % level for the conventional portfolio. This observation is remarkable as the US based mutual funds included in this portfolio claim to invest in the US. Furthermore, the observation is particularly notable since the US portfolios’ exposure to the market portfolio is highly significant.

The most evident explanation to this is the different construction of those indices. The market portfolio proxy is represented by the market portfolio factor supplied by the Kenneth French Data Library. The factor consists of the excess return on the value-weighted return of all CRSP (Center for Research in Security Prices) firms incorporated in the US and listed on the NYSE, AMEX or NASDAQ. Whereas, the local factor proxy is represented by the excess return on MSCI USA, which is an index constructed of the large and mid-cap segments of the US market. Consequently, the small cap firms are not represented. The analysis of the estimates of the “difference portfolio”

shows a statistically significant difference in the exposure to small caps between ethical and conventional mutual funds on the US market. The ethical portfolio has a higher exposure to small caps. Thus, it is credible that the local factor beta is significant for the conventional portfolio, but insignificant for the ethical portfolio.

Partial conclusion

It was noted in the analysis that the local factor beta was insignificant for the US ethical mutual funds, probably due to the exclusion of small cap stocks when constructing the local factor proxy.

The MSCI Sweden Index, MSCI Norway Index and MSCI Denmark Index are constructed in the same way. The local factor beta estimates for the regional investing fund portfolios in Sweden and Norway were expected to be higher, due to the fact that the mutual funds claim to invest locally.

The most likely reason behind the low estimates is once more the exclusion of the small cap stocks in the MSCI Indices. As, it is statistically proven that the majority of the Scandinavian fund portfolios are exposed to small cap stocks. Furthermore, the local indices are only including stocks from the mutual funds’ country of origin, while the Norwegian and Swedish mutual funds investment scope cover the entire Scandinavian area.

All mutual fund portfolios have a positive coefficient for the beta of the local factor, and a majority of those are statistically significant, which indicate an existence of home biases in SRI funds, aligned with earlier reports e.g. Bauer et al., (2006), Gregory and Whittaker, (2007), Cortez et al., (2012). Similar findings were published in Leite & Cortez (2014) study, which demonstrate a statistically significant positive coefficient for the average beta of the local factor. This implies that mutual funds have a tendency of favoring local securities. However, Leite & Cortez could not conclude that SRI funds have a significantly higher exposure to local holdings than their conventional counterparts, since the estimates were insignificant. Our study presents a higher exposure to local stocks for regional investing Swedish and Norwegian ethical portfolios relative to their conventional peers, indicating that the Swedish and Norwegian ethical funds to a higher extent focus on their home markets, rather than stocks from other Scandinavian markets.

To conclude, after it has been adjusted for market risk, size, book-to-market, momentum and home bias the difference in return between ethical and conventional funds remain statistically insignificant for all countries, except Norway.