Are fund managers willing to put skin in their ESG game?

New research examines managers' faith in sustainable and socially conscious companies' performance

Are fund managers willing to put skin in their ESG game?

In the world of investment, a fund manager’s confidence in the profitability of their approach is sometimes measured by their “skin in the game.” And when it comes to ESG, a new study of managers that offer both broad-based stock mutual funds and ESG-focused strategies offers some intriguing evidence.

According to new research by the Swiss Finance Institute, funds administered by managers who are also "co-investors" in a strategy – that is, they put at least some of their own money in the fund – are likely to have a considerably lower proportion of highly rated ESG equities than peers. This implies that these managers don't think these stocks will generate higher returns.

The study also discovered that co-investing managers frequently favour firms that score low on ESG metrics.

“Overall, our analysis indicates that fund managers do not expect ESG strategies to deliver higher risk-adjusted performance,” the paper said. “This suggests that the popularity of these strategies in the mutual fund industry is primarily driven by client demand — that is, by the possibility [that] fund managers [can] attract higher flows by tilting their portfolios in a higher-ESG direction.”

One of the three authors of the research, Vitaly Orlov, explained that their argument is supported by looking at how managers are paid.

“[For managers] whose compensation is tied to flows, what we find is that they invest more in high-ESG stocks,” he told Institutional Investor. “However, when these portfolio managers start to co-invest in their own funds, their overexposure to ESG almost completely reverses.”

An examination of 1,273 U.S. funds actively managed by 2,616 different managers from January 2015 to December 2020 served as the basis for Orlov and his colleagues' findings. The study focused only on diversified equity funds, which means the management could choose to invest or not to invest in ESG equities, as opposed to funds having a specific ESG mandate which were not examined in the study.

The Statement of Additional Information for a fund, an annual document that includes information about the ownership shares of portfolio managers, was used to examine management ownership.

The study estimates that 77% of the funds have management co-investments, with an average holding of US$802,208.

Professor Shivaram Rajgopal of Columbia University, who has performed multiple research studies on ESG-related subjects, said he isn't shocked by the result as it is typically challenging to merge the interests of managers and investors in ESG.

He told II that it's possible that these managers obtained their shares through an employee stock ownership program, in which the shares were discounted or given for free as a stock grant.

The amount of money that portfolio managers have in their own funds, though, surprised Rajgopal. That made him skeptical of the study's findings, saying that in such circumstances, it would be difficult to link management ownership to the managers' actual views on ESG.