Monday, October 27, 2008

Investment funds as religious entrepreneurs

Check out this article about religiously-themed investment funds from the latest Time Magazine titled "Which Religion Picks the Best Stocks?" These investment funds cater to financial investors of particular religious traditions by using religious ideals or doctrines to guide the selection of assets to purchase. For example, Amana Funds, which an Islamic-themed fund, does not purchase stocks with more than 5% stake in alcohol, pork, or tobacco, all of these being impure goods.

In terms of profitability, these religious funds should in general do worse on average than other, let's call them secular, funds. Why? First, if religious funds did better than secular funds, then secular funds would switch to the religious investing strategy and do better than when using a secular strategy. Hence, secular funds should not do worse on average than religious funds. Second, religious funds are restricting themselves to a smaller set of financial assets. Barring an incentive to confine one's choices (which can arise in very strategic settings but I think not so much in this investing settings), this should only act to reduce the return. This does not mean secular funds always do better in a certain period of time; fluctuations and randomness can generate all sorts of outcomes, such as during our current financial crisis. It just means that secular funds should do better than religious funds on average. The difference is what we can call the religious premium; the amount the investor pays (gives up) to retain a religiously satisfactory investment strategy. The stronger the restrictions on investing, the larger the premium.

But the fact that the religious funds are expected to do worse and yet still survive in the marketplace is what makes them much more interesting. As I see it, a religious fund is a type of religious entrepreneur. The reason investors use these funds even when they know that the return is lower is that they value, for religious reasons, the knowledge that their investments are in companies that produce ethically appropriate goods and services. This knowledge and satisfaction is tied directly towards their religious proclivities, and so the fund can actually be thought of as providing a religious good. Thus, we observe a religious good being produced and sold not by a church but by an investment firm.

We can take the logic even further. As long as the barriers to entry into the investment industry are low, we should actually expect these entrepreneurs to emerge. Moreover, the religious premium can be a measure of an investor's commitment to ethical investing. Just how much are you willing to forgo in expected profits to follow an ethical investing strategy?

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