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Religious investors underperform their peers

Religion and money have always had a bit of an awkward relationship. In the New Testament, Jesus overturns the money-changers’ tables in the Jerusalem Temple. In the Qur’an, the pursuit of money is a potential distraction from submission to Allah. Now, research from Spain adds to this ages-old opposition by showing that investment firms that choose stocks according to religious values perform more poorly than others. Making money, it seems, is just not a very religious thing to do – at least not when it comes to stocks.

Let’s face it: world’s economy isn’t always the most touchy-feely place. People make money by importing weapons, selling lung-killing cigarettes, brewing booze, and running factories that pollute rivers and lakes. Of course, it’s not all bad – plenty of companies grow their bottom line by doing things that help the world, or at least don’t hurt it. And in the past few decades, an increasing number of investment firms have advertised themselves as “socially responsible” – investing only in those companies that meet certain standards for environmental, social, or ethical practices. These firms allow people to feel pretty good about playing the stock market, because they know their money isn’t supporting activities they disapprove of.

In recent years, investment firms based on religious values have become an important part of the socially conscious investing scene. Religious or faith-based mutual funds may refuse to support companies that are involved in gambling, tobacco, pornography, abortion, or alcohol. Muslim mutual funds refuse to financially support banks or institutions that make their profits from interest, since usury is forbidden in Islam. Many Catholic and Protestant mutual funds in the U.S. go so far as to avoid companies that offer same-sex benefits to unmarried gay partners or politically support abortion rights.

Of course, if a religious mutual fund manager is screening all potential companies for their compatibility with the fund’s values, that means many opportunities for investing are probably lost. You might expect, therefore, that religiously based investment firms would not perform as well over the long term as mutual funds whose managers are allowed to invest in any company that looks like a good financial bet.

Luis Ferruz, Fernando Muñoz, and Mariá Vargas, all economists at the University of Zaragoza, wanted to find out the answer to exactly this question. So they assembled a massive set of data on the financial performance of 50 religiously based North American mutual funds and 119 non-religious, or conventional, funds, also North American, from January of 1994 to September of 2010. By examining the performance reports and running the data through a series of statistical analyses, they were able to highlight some important differences between the religious and conventional mutual funds.

Their results? In a nutshell, if you want to get rich… go conventional. Over the 16-year period, the conventional funds performed about as well as the stock market in general. That is, when the stock market was bullish, the conventional funds did well, when it was bearish they fared equally poorly. But the religious mutual funds consistently underperformed the broader stock market, meaning that their average returns were actually worse than one would expect from looking at the stock market as a whole.

Of course, the results of the study might cast doubt on active management in mutual funds in general. Active management is the strategy of intentionally picking which stocks to buy or sell and when, in the hopes that the returns will outperform the market. Neither religious nor conventional fund managers showed much ability to do this, since the conventional mutual funds just acted as an index of the market – that is, they merely matched its movements. Meanwhile, neither religious nor conventional fund managers showed any particular flair for timing their buying or selling, or anticipating the future actions of the market. But conventional managers did significantly better than their religious counterparts at stock-picking, or selecting stocks that prove to be high-performing.

The authors hypothesized that religious fund managers were less successful than their conventional brethren because they tended to use negative selection strategies. This means that, rather than telling their managers which types of stocks to look for, most religious mutual funds set guidelines for what sorts of companies to avoid. But prior research has strongly suggested that positive selection strategies are a better bet than negative ones. (Anyone who’s ever ridden a bicycle subconsciously knows this rule – if you suddenly find yourself careening toward an obstacle in the road, you don’t focus all your attention right at the obstacle as you try to avoid it. Instead, you look at the empty pavement just next to it. In other words, you focus on where you want to go, not where you don’t.)

What’s more, the stocks that the religious mutual funds were most likely to avoid  – alcohol and tobacco firms, weapons manufacturers, and pornography-related companies – typically show an exceptionally high return on investment. By cutting out the “sinful” companies, the religious mutual funds thus eliminated many of the most important sources of fast, high-return income for conventional funds.

There are a number of ways to interpret these findings. It could be that religious investors are simply naïve and ought to just get over their jitters and invest in the porn already. This would probably be more profitable, but it’s also probably not going to happen. Or it could be that the world of finance is a little bit corrupt, and if you try to be ethical you’re liable to get burned, like the one honest person playing cards with cheats and liars. But many other types of socially responsible investment firms perform just as well as their conventional fellows. For example, mutual funds that emphasize community involvement appear to perform just as well as those that eagerly buy up alcohol, tobacco, and weapons stocks. And there’s evidence to suggest that environmentally friendly companies are surprisingly strong stock performers, often delivering strong returns and profits.

So the religious mutual funds probably aren’t simply paying the price for being “good.” Instead, their managers may be making the mistake of relying too heavily on negative stock-picking strategies – focusing on where they don’t want their money to go, rather than where they do. In a sense, this negativity may reflect a broader cultural identity that the US conservative religious movement has forged for itself over recent decades, an identity that is often defined more by what its members stand against – pornography, gay marriage, abortion – than what they stand for. And as the example of the bike in the road shows, this isn’t always the best strategy. The better plan is often to focus on where you want to go, what you value, and go for that. This rule may just as true for your investment portfolio as for a cultural religious movement – or your wallet.

 

Click here for the abstract of the article, "Managerial Abilities: Evidence from Religious Mutual Fund Managers," in the Journal of Business Ethics.