Ethical Stock Market Indices

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Several indices are based on ethical investing, and include only companies that meet certain ecological or social criteria, such as the Calvert Social Index, Domini 400 Social Index, FTSE4Good Index, Dow Jones Sustainability Index, STOXX Global ESG Leaders Index, several Standard Ethics Aei indices, and the Wilderhill Clean Energy Index.

Other ethical stock market indices may be based on diversity weighting (Fernholz, Garvy, and Hannon 1998). In 2010, the Organisation of Islamic Cooperation announced the initiation of a stock index that complies with Sharia's ban on alcohol, tobacco and gambling.

Critics of such initiatives argue that many firms satisfy mechanical "ethical criteria", e.g. regarding board composition or hiring practices, but fail to perform ethically with respect to shareholders, e.g. Enron.

Indeed, the seeming "seal of approval" of an ethical index may put investors more at ease, enabling scams.

One response to these criticisms is that trust in the corporate management, index criteria, fund or index manager, and securities regulator, can never be replaced by mechanical means, so "market transparency" and "disclosure" are the only long-term-effective paths to fair markets.

From a financial perspective, it is not obvious whether ethical indices or ethical funds will out-perform their more conventional counterparts. Theory might suggest that returns would be lower since the investible universe is artificially reduced and with it portfolio efficiency.

On the other hand, companies with good social performances might be better run, have more committed workers and customers, and be less likely to suffer reputation damage from incidents (oil spillages, industrial tribunals, etc.) and this might result in lower share price volatility.

The empirical evidence on the performance of ethical funds and of ethical firms versus their mainstream comparators is very mixed for both stock and debt markets.

Reprinted from eTorothe copyright all reserved by the original author.

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