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Do green mutual funds perform well?

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DOI: 10.1108/01409171211247695

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Management Research Review
Emerald Article: Do green mutual funds perform well?
C. Edward Chang, Walt A. Nelson, H. Doug Witte

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To cite this document: C. Edward Chang, Walt A. Nelson, H. Doug Witte, (2012),"Do green mutual funds perform well?", Management
Research Review, Vol. 35 Iss: 8 pp. 693 - 708
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Green mutual
Do green mutual funds funds
perform well?
C. Edward Chang, Walt A. Nelson and H. Doug Witte
Finance and General Business Department, Missouri State University, 693
Springfield, Missouri, USA

Abstract
Purpose – The purpose of this paper is to compare the financial performance of green and traditional
mutual funds in the USA.
Design/methodology/approach – A total of 131 green mutual funds identified by US SIF, were
compared with the averages of all traditional mutual funds in their respective Morningstar categories.
Performance measures analyzed included annualized rates of return, expense ratios, and Sharpe ratios,
among others. Most data pertained to at least the past three years, while other data pertained to the
most recent 5 to 15 years.
Findings – The results demonstrate that green mutual funds have generated lower returns and
similar risks compared to traditional mutual funds in their respective Morningstar categories. Green
mutual funds have underperformed on a risk-adjusted basis.
Research limitations/implications – Since there is no formal definition of a green mutual fund, the
researcher and investor must make a subjective call in assessing which funds invest “green”. However,
at least in this early stage in the history of green investing, green mutual funds have underperformed
their peers.
Originality/value – Results confirm the limitations of green investing as suggested by various
researchers, among them Sharpe, Rudd and Kurtz and DiBartolomeo. Results stand in contrast to
Corson and Van Dyck and Statman, among others, which reported no significant underperformance
for socially responsible investments.
Keywords Green investments, Financial performance, Mutual funds, Social investing,
Return on investment, Risk, Financial risk, United States of America
Paper type Research paper

I. Introduction
According to US SIF (2010): The Forum for Sustainable and Responsible Investment,
socially responsible investments now account for over 10 percent of all assets under
professional management in the USA. Further, since 2005, socially responsible
investment assets have grown by more than one-third, while the broader universe of
professionally managed assets has remained virtually flat. These numbers confirm
that one of the biggest current trends in professional money management is toward
investing with a concern for environmental, social, and governance (ESG) issues.
Green investing is the most recent investment niche to emerge from the larger
socially responsible investment theme, with more emphasis towards environmental
issues. Examples include investments in traditional companies that minimize resource
usage in production, companies that produce renewable energy, and firms that produce
ecologically friendly products. Although the demand for green investments has grown
rapidly, the future of green investing likely depends on its ability to deliver returns that Management Research Review
Vol. 35 No. 8, 2012
are competitive to benchmark returns. pp. 693-708
The purpose of this paper is to address the following issue: do green mutual funds as a q Emerald Group Publishing Limited
2040-8269
group perform as well as the averages of all mutual funds in their respective categories? DOI 10.1108/01409171211247695
MRR The paper examines operating characteristics as well as risk and performance measures
35,8 of all available green mutual funds in the USA over the last 15 years. Operating
characteristics include expense ratios, annual turnover rates, and tax cost ratios.
Performance measures include average annual returns and return percentile rank in
category, risks (measured by standard deviations and betas) and risk-adjusted returns
(measured by the Sharpe ratios and alphas).
694
II. Literature review
Green investing is a relatively new subset of socially responsible investing. As such,
there are relatively few studies in the area. Additionally, there is no formal definition of
what constitutes a green investment. At this early stage, it is largely a subjective
assessment on the part of investors and funds as well. With these considerations in
mind this paper first reviews the literature on socially responsible investing before
turning attention to those studies exclusively focusing on green investing. Keefe (2007)
defines sustainable investing as the integration of ESG factors into financial analysis
and decision making, and argues that sustainable investing and socially responsible
investing are different. Socially responsible investing, often referred to as SRI, invests
according to largely social, non-economic, guidelines. Potential investments considered
by socially responsible funds (SRFs) may be positively screened for inclusion based
on criteria such as environmental responsibility, employee relations, or product safety.
Funds may also be negatively screened for exclusion based on a company’s
involvement in promoting, for example, alcohol, tobacco, gambling, or involvement in
the defense industry. Regardless of the real or perceived differences in sustainable
investing vis-à-vis SRI, green investing is a subset of both approaches given its
narrower focus on environmental issues. The degree to which green investing is a
smaller subset impacts the diversification that can be achieved and, therefore, may
subject green investors to more risk.
Proponents of socially responsible investment strategies (Camejo, 2002; Harrington,
1992) contend that it is possible for investors to “do well” while also “doing good”. They
suggest that socially responsible investing may produce higher risk-adjusted portfolio
returns relative to using all available stocks in the equity universe (Guerard, 1997a, b).
Kurtz (1997) proposes that socially responsible investing may be thought of as a tradeoff
of performance benefits and diversification costs. Benefits may take the form of more
competent and growth-minded management being more inclined to pursue better
environmental and corporate citizenship records as well as good employee relations.
Social responsibility may be indicative of management seeking to improve relations
with as many parties critical to their future success as possible. Diversification costs
may cut into these benefits because the social screens create portfolios that are
unbalanced with respect to industry weightings, average market capitalization, and
book-to-market ratios relative to their unscreened counterparts. Clow (1999) suggests
that social and environmental screens often result in the exclusion of old-line industrial
firms and generate a growth and technology bias in screened portfolios.
It can be argued, however, that the pursuit of a social agenda in the capital market
may require substantial financial sacrifices. At the firm level, complying with social
criteria which are not uniformly followed across an industry (which is the case
at present) increases operating costs and can put a firm at a disadvantage relative
to non-complying rivals (Aupperle et al., 1985; McGuire et al., 1988; Ullmann, 1985).
At the portfolio level, the degree to which green investing criteria limit the pool of Green mutual
available investments is likely to subject green investors to more risk. The smaller funds
subset of investment choices dictated by the green constraint can engender substantial
sector biases and increase nonsystematic risk (Kurtz and DiBartolomeo, 1996).
Rudd (1981) argues that the loss of diversification introduced by social screens
increases a screened portfolio’s covariation in returns unrelated to the market. Thus, the
loss of diversification is unlikely to be offset by an increase in returns, resulting in lower 695
risk-adjusted returns. Along this same line of argument, Sharpe (1965) demonstrates
that portfolios formed using a subset of all available investments cannot have a higher
return per unit of risk profile than portfolios formed using all available investments.
The case for green investing is possibly more compelling than socially responsible
investing for several reasons. First, as Vevenka (2010) notes, the green economy is not
so much driven by consumer or business demand, but rather is driven by government
policy, standards, subsidies, and regulation. The Kyoto protocol and proposed
legislation in the US congress are aimed at reducing greenhouse gas emissions. These
policies create a mandated demand for green power, which is still in relatively short
supply. In biofuel production, the US Government subsidizes production and mandates
usage. Additionally, a significant amount of the recent economic stimulus money
was earmarked for alternative energy technology. Second, with rising energy prices,
companies focused on energy conservation become more valuable and the potential
financial benefits from the development of breakthrough alternative energy
technologies increase. Third, to the extent global warming is taking place, Mincer
(2007) suggests several green companies are positioned to do well. For example, Toyota
Motor Corporation is widely thought to have industry leading hybrid engine technology.
Chia et al. (2009) find evidence of a green factor relating the returns of firms that are
beneficiaries of climate change. Lastly, with the world’s population increasing, the need
becomes greater for green companies that can maintain or increase production while
minimizing the use of the world’s natural resources.
Given the relatively recent development of green investing, it is not surprising that
academic studies on the topic are few. At the firm level, Boulatoff and Boyer (2009) find
that green firms underperformed comparable Nasdaq firms by 9 percent over a
five-year period ending in October 2008. Furthermore, the green firms had significantly
higher volatility. King and Lenox (2001) find a relationship between environmental
and financial performance, but cannot prove the direction of causality. They are also
unable to show that firms that move to cleaner industries see an improvement in their
financial performance.
At the fund level, Mallett and Michelson (2010) find that green fund returns are
similar to index returns. They also find little return difference between green funds
and SRFs, attributing this to the short time period that green funds have existed. The
number of green funds in their paper ranges from four to six, depending on the time
frame analyzed. Our paper analyzes 131 green mutual funds and has a balanced
analysis of risk and return, providing a more comprehensive view of green investing.
Sabbaghi (2010) studies 15 green funds over the 2005 through October 2009 timeframe.
He documents that green returns were quite good until the autumn of 2008, at which
time the average fund lost around 70 percent of its value. Unfortunately, the returns are
not benchmarked to any index, so it difficult to gauge how they compare to average
stock returns over any period. If we couple the time frame of Boulatoff and Boyer (2009),
MRR which ends in October 2008, with the steep decline in green stocks Sabbaghi finds over
35,8 the following year, green fund returns likely lag the market substantially. These results
highlight the very volatile nature of green investing. Investors need to be cognizant that
green funds tend to be heavily concentrated in a small number of sectors whose
fortunes are tied to the same fundamentals – energy prices, government policy, etc. The
firm and fund level findings of green underperformance roughly match the
696 performance documented for SRFs. Studies have generally found the risk/reward
profile of SRFs is, at best, comparable to benchmarks, but is often slightly inferior
(Renneboog et al., 2008).
We focus on the investment merits of green investing at the fund level. In the socially
responsible investing literature, empirical studies are typically one of three types. The
first type focuses on the performance of a social index, such as the Domini Social Index
(Corson and Van Dyck, 1992; Statman, 2000). A second type analyzes social responsibility
at the firm level, sorting individual stocks into portfolios based on a number of social
criteria (Diltz, 1995). A third type focuses on the performance of socially responsible
investment vehicles – mutual funds and ETFs. An early example is Hamilton et al. (1993)
which finds that the returns to socially responsible mutual funds are quite similar to
conventional mutual fund returns. Our analysis fits into this last group of studies in terms
of our similar focus on the return performance of green equities at the fund level.

III. Data and methodology

This study analyzes all green mutual funds in the USA having at least three-year data
available as of March 31, 2011. The green mutual funds examined in the present study
were identified by US SIF (http://ussif.org/) on March 31, 2011. US SIF, formerly the
Social Investment Forum (SIF), is the US membership association for professionals,
firms, institutions and organizations engaged in socially responsible and sustainable
investing. Green mutual funds are defined as mutual funds that seek investments
with positive (key: P) impact in at least one of the three areas (climate/clean tech.,
pollution/toxics, environment/other) under Screening and Advocacy/Environment
(http://ussif.org/resources/mfpc/screening.cfm). All data for individual green mutual
funds and category averages of mutual funds were collected from Morningstar’s
Principia database and its web site as of March 31, 2011. Table I shows the breakdowns
of the data used: 131 green mutual funds in 19 Morningstar fund categories. For proper
comparisons, we analyze green mutual funds relative to the appropriate category
averages based on matched (three, five, ten, and 15 years) periods. Table I also shows the
number of all mutual funds in those 19 Morningstar fund categories.
Morningstar categorizes funds according to a proprietary methodology with the
idea that its categories help investors and investment professionals make meaningful
comparisons between funds. While the investment objective stated in a fund’s
prospectus may not be a completely accurate description of how the fund actually
invests, the Morningstar category is assigned based on the underlying securities in each
portfolio and other portfolio statistics over the past three years. Given their excellent
reputation and widespread use by investors, we rely on Morningstar for proper
categorization of funds. Definitions of all categories are available at: www.morningstar.
com/InvGlossary/morningstar_category.aspx.
The primary statistical testing method used in this paper is a paired t-test for
means, which we contend is ideal in this setting. Each category of funds has one
 Green mutual
With three-year With five-year With ten-year With 15-year
data data data data funds
Green All Green All Green All Green All
Morningstar category MFs MFs MFs MFs MFs MFs MFs MFs

Equity energy 3 72
Foreign large blend 5 728 2 538 2 306 697
Foreign large value 7 290 5 221 5 136 5 n.a.
Foreign small/mid
growth 4 121
Large blend 23 1,757 23 1,471 21 816 11 n.a.
Large growth 20 1,505 18 1,312 18 818 10 n.a.
Large value 5 1,120 5 945
Mid-cap blend 2 380 2 304 2 185 2 n.a.
Mid-cap growth 9 682 5 603 4 401 4 n.a.
Mid-cap value 1 361
Small blend 3 577 3 487
Small growth 7 687 2 566
Utilities 1 84 1 78 1 52 1 n.a.
World stock 7 660 4 502 4 279 2 n.a.
Aggressive allocation 2 226 2 182 2 69 2 n.a.
Moderate allocation 11 932 11 734 8 408 7 n.a.
Conservative
allocation 2 592 2 442
High yield bond 3 506 3 430 3 288
Intermediate-term
bond 11 1,021 11 873 11 563 5 n.a. Table I.
Total of equity Numbers of green mutual
categories 97 9,024 70 7,027 57 2,993 35 n.a. funds identified by US
Total of all categories 126 12,301 99 9,688 81 4,321 49 n.a. SIF and available mutual
funds from Morningstar
Notes: MFs – mutual funds; n.a. – not available to the authors as of March 31, 2011

measurement (e.g. expense ratio) for the green mutual funds in the category paired
with the same measurement for all mutual funds in the category. We aggregate these
measurements across all fund categories, but not across different time periods so as
to avoid double counting. The main difference between a paired t-test and an otherwise
similar unpaired t-test is that the former takes into account the correlation between the
two groups. Table II, for example, shows that the Morningstar category of the green
mutual funds group with the highest (lowest) expense ratio is the same as the category
of the all mutual funds group with the highest (lowest) expense ratio. Taking into
account this type of correlation across groups incorporates an important characteristic
of the data and increases the power of our tests. The null hypothesis used is always
equality of means, with the alternative hypothesis being inequality of means. Hence,
two-sided p-values of the t-test are reported.
This paper empirically compares operating characteristics and performance
measures of green mutual funds relative to category averages in the US mutual fund
industry. Operating characteristics collected, averaged, and reported include: expense
ratios, annual turnover rates, and tax cost ratios.
The expense ratio is the annual fee all mutual funds charge investors. Expense ratio
is expressed as the percentage of assets deducted each fiscal year for fund expenses,
MRR
Expense ratio (%) Annual turnover (%) Tax cost ratio (%)
35,8 Morningstar category Green MFs AMFs Green MFs AMFs Green MFs AMFs

Equity energy 2.03 1.84 73.00 91.00 0.00 0.63

Foreign large blend 1.49 1.37 53.40 78.00 0.45 0.85
Foreign large value 1.89 1.39 119.29 64.00 0.52 1.04
698 Foreign small/mid growth 1.69 1.63 44.00 76.00 0.23 0.58
Large blend 1.16 1.12 42.48 73.00 0.37 0.54
Large growth 1.34 1.31 32.90 86.00 0.22 0.16
Large value 1.06 1.26 34.40 57.00 0.46 0.62
Mid-cap blend 1.12 1.34 40.50 88.00 0.52 0.30
Mid-cap growth 1.96 1.42 205.92 102.00 0.48 0.16
Mid-cap value 1.24 1.36 61.00 76.00 0.41 0.43
Small blend 1.77 1.39 174.00 71.00 0.01 0.35
Small growth 1.26 1.52 103.25 113.00 0.49 0.11
Utilities 1.92 1.41 53.00 137.00 0.39 1.38
World stock 1.30 1.49 62.57 74.00 0.31 0.59
Aggressive allocation 0.84 0.87 36.00 49.00 0.70 0.84
Moderate allocation 1.46 1.01 37.36 75.00 0.44 0.91
Conservative allocation 1.06 0.86 9.00 48.00 1.01 1.20
High yield bond 0.99 1.18 70.00 89.00 3.07 2.88
Intermediate-term bond 1.04 0.94 54.82 221.00 1.35 1.67
Average of equity categories 1.52 1.42 78.55 84.71 0.35 0.55
t-test (probability) 0.111 0.342 0.032 * *
Table II. Average of all categories 1.40 1.30 68.78 87.79 0.60 0.80
Expense ratio (%), t-test (probability) 0.061 * 0.092 * 0.010 * *
annual turnover (%),
and three-year tax cost Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category)
ratio (%) average of mutual funds

including 12b-1 fees, management fees, administrative fees, operating costs, and all
other asset-based costs incurred by the fund.
The turnover rate or ratio is a measure of the fund’s trading activity. Turnover ratio is
computed taking the lesser of purchases or sales (excluding all securities with maturities
of less than one year) and dividing by average monthly net assets. A turnover ratio of
100 percent does not necessarily suggest all securities in the portfolio have been traded.
The fund might have held 50 percent of all positions for the past five years and turned
over the other 50 percent of all positions twice throughout the year. A low turnover
rate would loosely indicate a buy-and-hold strategy. High turnover would suggest a
more active investment strategy involving considerable buying and selling of securities.
Morningstar’s tax cost ratio measures how much a fund’s annualized return is
reduced by the taxes investors pay on distributions. Funds regularly distribute
dividends and capital gains to their investors. Investors then must pay taxes on those
distributions during the year they are received. Like an expense ratio, the tax cost ratio
is usually concentrated in the range between 0 and 5 percent. A 0 percent tax cost ratio
indicates the fund had no taxable distributions. A higher tax cost ratio indicates the
fund was less tax efficient.
Performance measures include conventional return, risk, and risk-adjusted return
measures as suggested by Bodie et al. (2007). Annual average returns are measured by
mutual funds’ net asset value returns. Return percentile rank in category represents the
percentile rank the fund’s return had in its Morningstar category over the designated Green mutual
time frame. Returns are ranked from highest to lowest, with the best return having a funds
1 percent ranking and the worst a 100 percent ranking. These relative figures are
a good way to identify funds that out- or underperformed their peers during a certain
time period.
The standard deviation (a statistical measurement of dispersion about an average)
depicts how widely a fund’s returns varied over a certain period of time. Investors use 699
the deviation of historical performance to predict the range of returns most likely for
a given fund. When a fund has a high standard deviation, the predicted range of
performance is wide, implying greater volatility. Morningstar computes the standard
deviation by using the trailing monthly total returns for the appropriate time period.
All monthly standard deviations are then annualized. Standard deviation is also a
component in the Sharpe ratio, a risk-adjusted return measure developed by
Nobel Laureate William Sharpe. The Sharpe ratio is calculated by using both the
standard deviation and excess return to determine reward per unit of risk. The higher
the Sharpe ratio, the better is the fund’s historical risk-adjusted return performance.
Two statistics from modern portfolio theory are also used to shed light on green
mutual funds’ market risks and market-risk-adjusted returns. While standard deviation
is a measure of a fund’s absolute volatility, beta is a measure of a fund’s sensitivity to
market movements. Morningstar calculates beta using the correlation between a fund’s
excess return over Treasury bills and the market’s excess return over Treasury bills.
A fund beta of 1.5, for example, implies that the fund tends to have an excess return that
is “1.5 times” as much as the market. A low beta suggests that a fund’s return is not
particularly dependent on the market’s return. A stock can have high standard deviation
and yet a low beta if its volatility is not driven much by the movements of the broader
market. However, as is well known, a diversified fund comprised of at least 30 individual
investments will tend to have nearly all of its volatility driven by the broader market.
Thus, beta is particularly appropriate when used to measure the risk of a combined
portfolio of investments. Alpha is a measure of the difference between a fund’s actual
returns and its expected performance, given its level of risk as measured by beta. Thus,
alpha is a risk-adjusted measure of performance. A positive (negative) alpha indicates
the fund has performed better (worse) than expected, after adjusting for beta risk. For
example, an alpha of 2 percent indicates that the fund produced a return 2 percent higher
than its beta would predict using the CAPM model of returns.

IV. Results
Expense ratios, annual turnover rates, and tax cost ratios are shown in Table II.
Investors in green funds generally pay higher expenses, but do enjoy the benefits of
lower turnover and lower taxes. Green mutual funds as a whole have significantly
higher expense ratios (1.40 percent vs 1.30 percent), but lower turnover rates
(68.78 percent vs 87.79 percent), and lower tax cost ratios (0.60 percent vs 0.80 percent)
than the averages of all mutual funds in the same Morningstar category.
Green mutual funds have higher expense ratios in 12 of the 19 categories than
category averages. The exceptions are that funds in the categories of large value,
mid-cap blend, mid-cap value, small growth, world stock, aggressive allocation, and
high yield bond have lower expense ratios. Green mutual funds have lower turnover
rates in 16 of the 19 categories than category averages. The exceptions are that funds
MRR in the categories of foreign large value, mid-cap growth, and small blend have higher
35,8 turnover rates. Green mutual funds have lower tax cost ratios in 14 of the 19 categories
than category averages. The exceptions are that funds in the categories of large
growth, mid-cap blend, mid-cap growth, small growth, and high yield bond have
higher tax cost ratios.
Green mutual funds generally underperform in terms of return. Table III shows
700 results of average annual returns over the three-, five-, ten-, and 15-year period ending
on March 31, 2011. Green mutual funds, as a whole, have significantly lower returns
than the category averages over a five-year period (2.22 percent vs 3.45 percent) and a
ten-year period (3.92 percent vs 5.10 percent). Results over the three- and 15-year
periods are inconclusive.
Green mutual funds of a few categories do outperform. For example, green mutual
funds in the categories of large blend (five and ten years), large growth (ten year),
mid-cap blend (five and ten years), utilities (five year), and high yield bond (five year)
have higher returns than category averages.
Results of return percentile rank in category are similar, as shown in Table IV.
Green mutual funds appear to display lower return percentile rank in category than

Three year Five year Ten year 15 Year

Green Green Green Green
Morningstar category MFs AMFs MFs AMFs MFs AMFs MFs AMFs

Equity energy 218.25 0.34

Foreign large blend 22.31 2 2.74 20.21 1.33 2.10 5.01
Foreign large value 27.34 2 3.25 23.73 0.90 1.62 5.99 2.34 6.55
Foreign small/mid
growth 21.74 0.98
Large blend 2.76 1.98 2.29 2.13 3.69 3.28 7.16 6.44
Large growth 3.00 3.57 1.79 3.08 3.59 2.91 7.37 6.33
Large value 0.77 1.29 0.37 1.65
Mid-cap blend 10.05 6.42 4.44 3.98 7.74 7.61 10.99 8.59
Mid-cap growth 11.98 6.68 3.60 4.32 2.42 5.91 5.69 7.97
Mid-cap value 16.39 6.39
Small blend 5.29 8.02 2.28 3.13
Small growth 6.01 8.77 24.30 3.56
Utilities 2.88 2 0.38 5.85 5.32 2.95 3.93 7.62 7.80
World stock 0.23 0.78 2.18 2.68 4.65 5.25 6.17 6.92
Aggressive allocation 2.23 2.94 2.95 3.10 4.06 4.93 7.45 6.81
Moderate allocation 2.37 3.53 2.33 3.55 2.56 4.36 4.94 6.27
Conservative allocation 2.94 4.27 3.30 4.07
High yield bond 8.58 9.69 7.31 6.86 6.63 6.85
Intermediate-term bond 4.46 5.63 5.05 5.50 4.98 5.15 5.59 5.60
Average of equity
categories 2.12 2.78 1.32 2.92 3.60 4.99 6.76 7.23
t-test (probability) 0.355 0.031 * * 0.041 * * 0.299
Average of all
categories 2.65 3.42 2.22 3.45 3.92 5.10 6.53 6.93
t-test (probability) 0.273 0.019 * * 0.014 * * 0.260
Table III.
Average annual Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category)
return (%) average of mutual funds
 Green mutual
Three year Five year Ten year 15 Year
Green Green Green funds
Morningstar category MFs AMFs Green MFs AMFs MFs AMFs MFs AMFs

Equity energy 95.67 50.00

Foreign large blend 44.80 50.00 77.00 50.00 92.00 50.00
Foreign large value 86.29 50.00 95.80 50.00 97.60 50.00 97.60 50.00 701
Foreign small/mid
growth 80.25 50.00
Large blend 39.91 50.00 47.61 50.00 48.10 50.00 32.73 50.00
Large growth 53.20 50.00 63.56 50.00 36.61 50.00 28.70 50.00
Large value 57.60 50.00 69.40 50.00
Mid-cap blend 14.00 50.00 42.50 50.00 48.50 50.00 17.00 50.00
Mid-cap growth 26.00 50.00 58.20 50.00 90.75 50.00 83.00 50.00
Mid-cap value 1.00 50.00
Small blend 82.00 50.00 63.67 50.00
Small growth 59.57 50.00 100.00 50.00
Utilities 24.00 50.00 33.00 50.00 68.00 50.00 51.00 50.00
World stock 54.86 50.00 55.75 50.00 57.25 50.00 59.00 50.00
Aggressive allocation 68.50 50.00 57.00 50.00 75.00 50.00 32.00 50.00
Moderate allocation 74.64 50.00 77.82 50.00 86.50 50.00 76.86 50.00
Conservative
allocation 77.50 50.00 73.50 50.00
High yield bond 81.33 50.00 47.67 50.00 68.67 50.00
Intermediate-term
bond 72.55 50.00 65.18 50.00 58.00 50.00 50.40 50.00
Average of equity
categories 51.37 50.00 64.23 50.00 67.35 50.00 52.72 50.00
t-test (probability) 0.430 0.023 * * 0.037 * * 0.408
Average of all
categories 57.56 50.00 64.23 50.00 68.92 50.00 52.83 50.00
t-test (probability) 0.115 0.003 * * * 0.004 * * * 0.371
Table IV.
Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category) Return percentile
average of mutual funds rank in category

category average over a five-year period (64.23 percent vs 50.00 percent) and a ten-year
period (68.92 percent vs 50.00 percent). Results over the three- and 15-year periods are
also inconclusive.
Green mutual funds of the same categories as above also outperform. They are
green mutual funds in the categories of large blend (five and ten years), large growth
(ten year), mid-cap blend (five and ten years), utilities (five year), and high yield bond
(five year) have higher returns than category averages.
Table V shows results of standard deviations (stand-alone or total risk) over the
three-, five-, ten-, and 15-year period ending on March 31, 2011. Green mutual funds, as a
whole, exhibit similar standard deviations as the category averages over all time periods.
Green mutual funds generally have lower Sharpe ratios. Table VI shows results of
Sharpe ratios over the three-, five-, ten-, and 15-year period under study. Green mutual
funds, as a whole, exhibit lower Sharpe ratios than the category averages over a
five-year period (0.17 vs 0.21) and a ten-year period (0.25 vs 0.31). Results over the
three-year and 15-year periods are inconclusive.
MRR
Three year Five year Ten year 15 Year
35,8 Green Green Green Green
Morningstar category MFs AMFs MFs AMFs MFs AMFs MFs AMFs

Equity energy 36.93 34.60

Foreign large blend 25.23 26.81 20.27 22.00 17.64 18.84
702 Foreign large value 27.74 27.46 22.82 22.15 18.95 18.89 18.33 17.31
Foreign small/mid
growth 26.26 28.55
Large blend 22.31 22.57 18.21 18.55 16.35 16.51 16.43 15.99
Large growth 22.42 22.82 18.64 19.18 16.74 17.85 17.75 18.57
Large value 24.25 22.59 19.69 18.39
Mid-cap blend 34.22 26.05 27.29 21.42 21.44 18.95 19.80 17.49
Mid-cap growth 24.68 25.28 19.76 21.20 19.25 19.94 21.03 21.84
Mid-cap value 19.32 25.93
Small blend 25.44 27.50 20.73 22.35
Small growth 28.09 26.55 29.73 22.36
Utilities 21.30 18.60 18.14 16.20 16.81 15.49 15.95 13.82
World stock 24.42 24.65 18.48 20.32 16.40 18.11 16.16 16.86
Aggressive allocation 16.42 19.64 13.45 16.02 10.95 13.66 10.47 13.06
Moderate allocation 15.08 15.64 12.28 12.72 11.46 10.78 12.93 10.55
Conservative allocation 8.99 11.19 7.19 8.93
High yield bond 13.15 15.34 10.48 12.37 8.31 10.14
Intermediate-term bond 4.14 5.88 3.54 4.88 3.81 4.40 3.98 3.77
Average of equity
categories 25.90 25.71 21.25 20.37 17.95 18.07 17.92 17.41
t-test (probability) 0.416 0.187 0.405 0.180
Average of all
categories 22.13 22.51 17.54 17.44 14.84 15.30 15.28 14.93
t-test (probability) 0.293 0.443 0.150 0.254
Table V. Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category)
Standard deviation (%) average of mutual funds

Green mutual funds of a few categories do outperform. For example, green mutual
funds in the categories of large blend (ten year), large growth (ten year), mid-cap
blend (five year), utilities (five year), high yield bond (five and ten years) and
intermediate-term bond (five and ten years) have higher Sharpe ratios than category
averages.
Table VII shows results for betas (market risk) over the three-, five-, ten-, and
15-year period ending on March 31, 2011. Green mutual funds, as a whole, exhibit betas
similar to the category averages over all time periods.
Table VIII shows results of alphas (market-risk-adjusted excess returns) over the
three-, five-, ten-, and 15-year period under study. Green equity mutual funds, as a
whole, exhibit lower alphas (2 0.54 percent vs 0.53 percent) than the category average
over a five-year period. Results over all other periods are inconclusive. Because betas
and alphas may not be applicable to bond funds, implications of alphas, though also
lower, will not be emphasized.
Over the five-year period, green mutual funds in all categories have lower alphas
than category averages with the following exceptions. Green mutual funds in the
 Green mutual
Three year Five year Ten year 15 Year
Green Green Green Green funds
Morningstar category MFs AMFs MFs AMFs MFs AMFs MFs AMFs

Equity energy 20.35 0.19

Foreign large blend 0.01 0.02 2 0.01 0.08 0.09 0.24
Foreign large value 20.15 0.01 2 0.14 0.06 0.07 0.29 0.05 0.23 703
Foreign small/mid
growth 0.05 0.17
Large blend 0.21 0.18 0.10 0.10 0.18 0.15 0.32 0.23
Large growth 0.22 0.25 0.08 0.15 0.17 0.13 0.32 0.22
Large value 0.14 0.16 0.01 0.08
Mid-cap blend 0.44 0.36 0.23 0.20 0.36 0.38 0.47 0.41
Mid-cap growth 0.55 0.37 0.18 0.21 0.11 0.29 0.22 0.30
Mid-cap value 0.86 0.36
Small blend 0.32 0.41 0.11 0.16
Small growth 0.36 0.44 2 0.07 0.18
Utilities 0.22 0.05 0.29 0.28 0.13 0.20 0.35 0.36
World stock 0.12 0.14 0.10 0.13 0.22 0.26 0.26 0.25
Aggressive allocation 0.19 0.22 0.13 0.14 0.23 0.27 0.44 0.28
Moderate allocation 0.20 0.28 0.08 0.18 0.10 0.26 0.19 0.30
Conservative allocation 0.32 0.40 0.20 0.27
High yield bond 0.66 0.69 0.53 0.45 0.56 0.51
Intermediate-term bond 0.99 0.98 0.83 0.76 0.73 0.70 0.59 0.57
Average of equity
categories 0.21 0.22 0.08 0.15 0.17 0.24 0.28 0.29
t-test (probability) 0.449 0.013 * * 0.031 * * 0.486
Average of all
categories 0.28 0.30 0.17 0.21 0.25 0.31 0.32 0.32
t-test (probability) 0.355 0.020 * * 0.024 * * 0.430
Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category) Table VI.
average of mutual funds Sharpe ratio

categories of large blend, mid-cap blend, utilities, aggressive allocation, high yield
bond, and intermediate-term bond have higher alphas than category averages.

V. Discussions and implications

The last decade has seen a significant increase in the demand for green investments.
Seeking to invest in ways that are environmentally friendly, investors have poured
billions of dollars into green mutual funds and the industry has responded in kind with
an ever-increasing menu of fund choices. A complimentary tailwind has been provided
in the form of governmental subsidies, mandates, and large amounts of public stimulus
money steered towards green initiatives. Given these tailwinds, it is hard to imagine
green mutual funds not doing well. Our results, however, indicate that, in spite of
generous public subsidies for ostensibly “green” initiatives, green mutual funds have
to date achieved relatively poor risk-adjusted returns.
The implications for the marketing and future performance of green funds are
significant. Marketers need to convey to potential investors that significant risks are posed
by uncertainty with respect to governmental policy. Subsidization and usage mandates
in the future are uncertain. Investors have to realize that in a policy environment that
MRR
Three year Five year Ten year 15 Year
35,8 Green Green Green Green
Morningstar category MFs AMFs MFs AMFs MFs AMFs MFs AMFs

Equity energy 1.44 1.24

Foreign large blend 0.94 1.00 0.92 1.01 0.93 1.00
704 Foreign large value 1.05 1.03 1.04 1.00 1.01 0.99 1.03 0.98
Foreign small/mid
growth 0.98 1.04
Large blend 1.00 1.01 1.00 1.00 1.00 0.99 0.96 0.97
Large growth 1.00 1.00 1.01 1.01 0.99 1.04 0.98 1.07
Large value 1.07 1.01 1.06 1.01
Mid-cap blend 1.46 1.13 1.41 1.11 1.16 1.07 0.95 1.00
Mid-cap growth 1.04 1.08 1.01 1.09 1.07 1.11 1.08 1.13
Mid-cap value 0.80 1.14
Small blend 1.06 1.17 1.06 1.18
Small growth 1.16 1.12 1.46 1.14
Utilities 0.87 0.70 0.88 0.72 0.87 0.74 0.75 0.65
World stock 0.89 0.90 0.82 0.88 0.82 0.90 0.75 0.92
Aggressive allocation 1.10 1.33 1.11 1.34 1.04 1.32
Moderate allocation 1.01 1.05 1.02 1.07 1.05 1.06
Conservative allocation 0.60 0.73 0.60 0.72
High yield bond 0.96 1.03 0.76 0.85 0.42 0.43
Intermediate-term bond 0.82 1.00 0.83 0.98 0.88 0.95 0.87 0.96
Average of equity
categories 1.05 1.04 1.06 1.01 0.98 0.98 0.93 0.96
t-test (probability) 0.375 0.163 0.482 0.193
Average of all
categories 1.01 1.04 1.00 1.01 0.94 0.97 0.92 0.96
t-test (probability) 0.249 0.424 0.164 0.119
Table VII. Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category)
Beta average of mutual funds

has become very friendly to green initiatives, green funds and companies have not thrived.
In fact, contemporaneous news reports indicate that many companies producing green
products, such as solar panels, are encountering financial hardship due to reductions
in government stimulus as well as stiffer foreign competition. Because green initiatives
apparently require government subsidies and usage mandates, ongoing government
funding becomes an electoral issue whose outcome adds an extra level of uncertainty for
green investors to consider.
There are many possible explanations for the poor performance of green funds. One
is that given the relatively early stage in the product life cycle, green companies
are incurring massive research and development costs that will only generate future
profits. It is possible that investors somewhat underestimated these initial costs and
overestimated the current profitability of green companies. Growing disappointed,
investors have bid down fund prices and the fund performance has not matched that of
traditional funds. Our results are not inconsistent with this scenario.
A second possibility is that green investing is simply another investment fad that
fund management firms have exploited by promoting an increasing number of green
funds with high expense ratios. Retail investors likely purchase these costly funds
 Green mutual
Three year Five year Ten year 15 Year
Green Green Green Green funds
Morningstar category MFs AMFs MFs AMFs MFs AMFs MFs AMFs

Equity energy 219.12 1.07

Foreign large blend 0.44 0.48 21.63 0.08 23.00 2 0.51
Foreign large value 24.07 0.19 24.78 2 0.49 23.55 0.64 22.19 1.14 705
Foreign small/mid
growth 1.40 4.86
Large blend 0.47 20.22 20.27 2 0.52 0.44 2 0.46 0.56 20.93
Large growth 0.73 1.38 20.71 0.07 0.44 2 1.09 0.86 21.10
Large value 21.32 20.80 22.00 2 1.22
Mid-cap blend 8.76 4.53 3.00 1.57 4.89 3.76 4.72 2.36
Mid-cap growth 9.38 4.70 1.30 1.44 20.43 1.91 20.53 1.13
Mid-cap value 13.22 4.33
Small blend 3.40 6.17 0.09 0.64
Small growth 4.49 6.74 24.95 0.70
Utilities 1.00 22.13 3.44 2.58 0.14 1.19 1.92 1.77
World stock 2.90 3.53 0.53 0.96 20.18 2 0.12 1.91 1.49
Aggressive allocation 22.65 22.56 22.62 2 3.04 22.59 2 3.25
Moderate allocation 22.27 21.16 23.01 2 2.24 24.00 2 2.68
Conservative allocation 20.30 0.64 20.90 2 0.44
High yield bond 4.11 5.17 2.63 1.67 3.26 3.35
Intermediate-term bond 0.09 0.03 20.28 2 0.79 20.16 2 0.56 20.17 20.67
Average of equity
categories 1.55 2.49 20.54 0.53 20.16 0.67 1.04 0.84
t-test (probability) 0.302 0.063 * 0.147 0.403
Average of all
categories 1.09 1.94 20.64 0.06 20.40 0.18 0.89 0.65
t-test (probability) 0.258 0.078 * 0.137 0.368
Notes: Significant at: *0.10, * *0.05 and * * *0.01 levels; MFs – mutual funds; AMFs – (category) Table VIII.
average of mutual funds Alpha (%)

primarily because they want their money invested in a way that is friendly to the
environment. Green funds, cognizant that fund inflows are mostly due to the nature of
the fund’s investment philosophy and not due to the fund’s investment performance,
have focused more on the former (and charged a hefty price for the “green label”) than
the latter. If this scenario is true, we can expect green fund performance to improve
once investors become less myopic about simply investing green. The funds will have
to deliver competitive returns in order to survive.
One possibility that is inconsistent with our results is that green funds have performed
poorly because of a lack of diversification. We find that in terms of risk-adjusted returns,
green funds have underperformed their conventional counterparts. Using the Sharpe
ratio, for example, this underperformance conceptually could be attributed to low returns,
high risk, or both. However, our analyses that focus on risk only – beta and standard
deviation – all suggest that green funds have similar risk to their benchmarks. Thus, the
poor performance of green funds to date can be attributed to lower returns and not to
higher risk. Our findings are contrary to those of Mallett and Michelson (2010) which
finds green funds deliver returns similar to index funds. Our findings of similar beta and
MRR standard deviation for green funds also runs contrary to the findings of Rudd (1981)
35,8 which suggest screened portfolios (e.g. green funds) have more diversifiable risk.
Normatively, it is imperative that fund managers identify the ideal green portfolio.
Although the results in this study indicate that such a portfolio has not yet been
assembled, this outcome should only serve as motivation to continue the effort. This
would require, for example, a better definition of green company procedures and
706 characteristics to replace the host of poorly defined green metrics in current use. Fund
managers might also compare the performance of green companies which operate
without subsidies to those which do. If there is a difference in financial performance,
mutual fund managers can adjust their portfolios accordingly.
While we have documented the nature of green fund underperformance, we have
only offered conjectures for causation. Further studies on green fund are needed to
learn more about the way in which their returns are generated. Perhaps, multiple factor
models, which attribute returns to more than just a fund’s beta and the market risk
premium, will prove fruitful in this endeavor.

VI. Conclusion
Green investing is an investment philosophy gaining popularity not only in the USA,
but also in many other countries around the world. While initially driven by investor
desire to invest funds in companies that are environmentally friendly, the future of
green mutual funds will likely depend on their ability to deliver competitive returns.
The question addressed in this paper is whether a green investment agenda sacrifices
return performance. We empirically compare operating characteristics as well and risk
and performance measures of US green mutual funds and conventional mutual funds
in the same Morningstar categories over the last 15 years.
Results of this study indicate that so-called “do-good” or “green” mutual funds in
the USA have not generated competitive returns relative to other mutual funds in the
same fund categories over the past 15 years. Green mutual funds, as a whole and over
the past five- and ten-year periods, exhibit higher expense ratios, lower return
measures, and lower risk-adjusted return measures when compared with the averages
of all mutual funds in the same category. Green mutual funds do report lower annual
turnover rates and lower tax cost ratios, however. Green mutual fund risk appears to
be similar to conventional funds, suggesting the green investment constraint does not
engender more risk.
The results indicate that, so far, green mutual funds underperform. Green mutual
funds must do better in the future to close the gap with their conventional peers. While
returns and risk-adjusted returns for green mutual funds tend to be lower than their
conventional peers, it should be noted that green performance is not uniformly inferior
across fund types. Some green mutual funds, including those in the categories of large
blend, large growth, mid-cap blend, utilities, high yield bond, and intermediate-term
bond, have at times performed better, with higher returns and risk-adjusted returns,
than their category averages over the same periods under study.
There is hope for green investors, however. First, many firms already manage
operations with an eye toward energy efficiency, itself a green concept. Once achieved,
energy efficiency reduces costs and increases profits and such profits are reflected in
the price of the stock. So, one avenue for green investors is to define “green” by the
ability of firms to achieve energy efficiency, which is more or less quantifiable.
Second, the market will eventually standardize the definition of “green” company Green mutual
management and most companies will aspire and obtain the standard, much as they funds
already adhere to generally accepted accounting principles. Meanwhile, green
investors should be selective in their choice of investments and should consider
long-term horizon for their investment decisions.

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About the authors

C. Edward Chang is a Professor in the Department of Finance and General Business at Missouri
State University, Springfield, Missouri. He has a PhD from the University of Illinois at
Urbana-Champaign. His articles have been published in Managerial Finance, Financial Services
Review, American Journal of Business, Journal of Multinational Financial Management, Applied
Financial Economics, Real Estate Review and Financial Practice and Education. His current
research interests are performance measurement of investment vehicles and financial education.
C. Edward Chang is the corresponding author and can be contacted at: EdwardChang@
MissouriState.edu
Walt A. Nelson is an Associate Professor in the Department of Finance and General Business
at Missouri State University, Springfield, Missouri. He has a PhD from Georgia State University.
His articles have appeared in Managerial Finance and Journal of Taxation of Investments. His
current research interests focus on the multi-family housing market.
H. Doug Witte is an Assistant Professor in the Department of Finance and General Business
at Missouri State University, Springfield, Missouri. He has a PhD from the University of Arizona.
His articles have been published in the American Journal of Business, Studies in Economics and
Finance and International Review of Financial Analysis. His current research interests are in the
areas of financial markets and international finance.

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