The Opportunity Cost of Discipleship: Ethical Mutual Funds and Their Returns

Iannaccone's (1988) formal model of church and sect predicts that members of sects, defined as groups with moral or ethical standards at variance with the social environment, should suffer costs because of their adherence to their standards. After noting the strong resemblance of this notion to that of Bonhoeffer's concept of costly grace (1963), the empirical validity of the hypothesis is tested by examining the performance of ten mutual funds that impose ethical restrictions on their portfolios. Nine of the ten had risk-adjusted returns lower than their category average over a five-year period. On average, an ethical investor sacrificed about one percentage point of return per year compared to comparable funds, or about ten percent of the return that otherwise could have been expected. This finding provides solid support for Iannaccone's hypothesis. Certain implications and extensions of this finding are then discussed.