Three Essays on Sustainable Mutual Funds

Abstract

Climate change is one of the most crucial contemporary challenges facing society and businesses. The Paris Agreement, an international treaty adopted in 2015 on climate change by 196 parties at the UN Climate Change Conference (COP21) in Paris, France, highlights this necessity, stating that if climate change is to be mitigated, it is essential to align financial flows with goals that lead to reduced greenhouse gas (GHG) emissions and the promotion of climate-resilient development (Fichtner et al., 2023). Environmental, social and governance (ESG) funds are the most prominent sustainable financial instrument in the US market, and they continue to attract new inflows. Indeed, the asset under management of these funds increased ten-fold from $5 billion in 2018 to over $50 billion in 2020, then to almost $70 billion in 2021 (Jozkowski, 2023).
Given the double materiality (impact materiality and financial materiality) of ESG investing, it is vital to understand the unique characteristics and their potential impact on investors’ decisions. This thesis aims to tackle three key issues from the perspectives of ESG fund operations and investor behaviour.
Chapter 1 briefly introduces the main findings and contributions of this thesis. Chapter 2 focuses on ESG rebranding, the process whereby non-ESG mutual funds rebrand to ESG funds. Previous research on mutual fund rebranding reveals a deceptive strategic setting which only seeks to attract capital without delivering any substantial shift in investment style (Cooper et al., 2006; Espenlaub et al., 2017). Unlike conventional funds, ESG funds are supposed to focus on both financial returns and non-financial outcomes (i.e. ethical considerations). Given this, it is important to examine whether the pressure to adhere to business ethics results in a more substantial and genuine transformation of the ‘rebranding’. By the end of 2021, more than one third of the entire US equity fund market had rebranded to ESG. It is necessary to investigate whether funds fulfil their commitment to investors regarding ESG performance. Despite rebranding leading to a significant increase in abnormal flows (more than 1.3% for rebranded ESG funds and 0.9% for non-ESG funds within the same family), there is no corresponding outperformance by ESG funds. ESG performance to align with their advertised (changed) ESG investment strategies.
Following Chapter 2, Chapter 3 also provide evidence of ESG funds engaging in ‘unethical’ practices towards their investors. Chapter 3 examines whether fund families exploit the characteristic patience of ESG investors, who prioritise non-financial factors and tolerate lower performance from ESG funds, by charging higher fees. The findings show that fund families capitalise on the low performance sensitivity of retail ESG investors to impose higher fees on ESG funds, thereby exploiting these investors’ level of financial sophistication. Such exploitative fee-setting practices are not observed in institutional funds.
Chapter 4 examines the effect that the Paris Agreement has on sustainable investment preferences among investors and the asset allocation decisions of fund managers (i.e., whether fund managers are prone to allocating more money to stocks offering more sustainable performance). We introduce the Media Climate Change Concerns Index (MCCC), a metric developed by Ardia et al. (2023) to measure media concerns about climate risk. This index emphasises the role that the Paris Agreement plays in shaping investment preferences for ESG investments among two key participants in mutual funds: investors and fund managers. Post- Paris Agreement, it demonstrates that media climate risk more effectively translates into actual trading behaviour, experiencing a 1.5% increase in inflows to sustainable mutual funds compared to non-sustainable funds. Fund managers are observed to actively respond to media-climate risks and contribute to an average 20% reduction in carbon intensity (defined as total Scope 1 and 2 carbon emissions to total revenue, CI hereafter) at the fund level.
This thesis contributes to the existing body of literature concerning the commitment of ESG mutual funds by providing new evidence of fee-setting and rebranding strategies. Furthermore, it deepens our understanding of the double materiality of ESG investments and whether ESG funds consistently adhere to their ethical investment principles. It also adds value by investigating how investors interpret and react to signals from ESG funds, and the influence of external ESG signals on ESG fund managers’ decisions.

Date of Award	12 Sept 2024
Original language	English
Awarding Institution	University of Bath
Supervisor	Hanwen Sun (Supervisor) & Paul Baker (Supervisor)