Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows

As firms invest more resources in sustainable and socially responsible endeavors, it is important to know whether such investments reflect investor's preferences marketwide. Some investors will believe that an increase in resources directed towards sustainability is costly and belies the primary goal of maximizing profits. Others will believe that a well-run company should care about the environment or that companies should act for reasons beyond simple value maximization. Others still will value such an investment not because they inherently care about the environment, but because they view it as a sound way to maximize profit. And finally, some investors will be unaware that a firm is investing in sustainability or will not care. While surely the market contains examples of each of these investors, it remains unclear which type represents the average investor and thus it is unclear whether investments in sustainability are consistent with what investors want. Put simply, do investors collectively view sustainability as a positive, negative, or neutral attribute of a company?

This paper demonstrates that the universe of mutual fund investors in the US collectively put a positive value on sustainability by providing causal evidence that marketwide demand for funds varies as a function of their sustainability ratings. While directly addressing this question is difficult in most settings, we circumvent the typical challenges by examining a novel natural experiment where the salience of the sustainability of over $8 trillion of mutual fund assets experienced a large shock. Sustainability went from being difficult to understand to being clearly displayed and touted by one of the leading financial research websites, Morningstar. In March of 2016, Morningstar first published sustainability ratings where more than 20,000 mutual funds were ranked based on the sustainability of their holdings. Prior to the publication, there was not an easy way for investors to judge the sustainability of most mutual funds without considerable effort. Over the 11 months after the sustainability ratings were published, we estimate between 12 and 15 billion dollars in assets left low sustainability funds and between 24 and 32 billion dollars in assets entered high sustainability funds as a result of their globe rating.

The large causal flow response we observe allows us to reject both the hypothesis that investors are indifferent to sustainability as well as the hypothesis that they view sustainability as a negative characteristic, but it leaves open the question of which specific aspect of sustainability drove investors to reallocate funds from one globe funds to five globe funds. The flow pattern is present among institutional share classes, especially for high sustainability funds, consistent with social constraints placed upon institutions being partially responsible for the effect. However, the pattern persists among non-institutional investors as well. We do not find evidence supporting a rational belief that more sustainable funds perform better, instead the evidence is more consistent with the opposite. In spite of this, our experimental evidence suggests that investors have a strong belief that better globe ratings positively predict future returns. We also find suggestive evidence of non-pecuniary motives, consistent with altruism or warm glow.