Is individual investors' ESG appetite under pressure?

Analysis of fund flows suggests COVID-19 is weighing on retail investors' commitment to ESG

Is individual investors' ESG appetite under pressure?

The recent coronavirus-driven market crisis has been a valuable testing ground for many hypotheses about investing, including those regarding ESG. From a performance and risk-mitigation perspective, the evidence has been largely promising, with numerous reports touting how high-scoring ESG funds have weathered the crisis better than their benchmarks and less sustainability-focused peers.

But one study suggests a not-so-positive trend when it comes to retail investor appetite.

In a paper titled Sustainability Preferences Under Stress: Evidence from Mutual Fund Flows During COVID-19, researchers from Erasmus University Rotterdam and the University of Florida examined patterns in mutual fund flows to determine whether investors’ preference for ESG has been impacted by the outbreak.

“In a difference-in-differences framework using retail fund ow and sustainability rating data from Morningstar, we find that investor preference for sustainability significantly weakens under economic and market stress,” the authors of the research said.

They said that before the crisis, high ESG funds – those with high Morningstar sustainability ratings – enjoyed higher-than-average weekly retail fund flows. But they lost those relatively higher capital flows after the pandemic first started slamming markets during the week of February 22.

They also found that those high ESG funds were more likely than the average fund to suffer net retail redemptions during the COVID-19 crisis compared to before.

“Moreover, this shift in flow persists into the weeks from March 28 to April 25, when the market rebounded dramatically after the US stimulus package was announced on March 23,” the authors said.

But when it comes to institutional investors, they found that inflows into high ESG funds were not dampened, and only low ESG funds saw sharp but temporary drops in inflows during the early crash period. To explain the difference, they pointed to the high minimums and substantially lower expense ratios that typically characterize institutional share classes of mutual funds, as well as a greater prominence of strong ESG mandates among institutional investors.

“[O]ur evidence on retail flows [is] consistent with a shift away from sustainability preference, a perceived luxury good that investors no longer find affordable under financial stress induced by the COVID-19 shock,” the researchers said.


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