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

• DOI: http://doi.org/10.1111/jofi.12841
• Author: ABIGAIL B. SUSSMAN,SAMUEL M. HARTZMARK
• Date: 01 December 2019
• Published date: 01 December 2019

THE JOURNAL OF FINANCE •VOL. LXXIV, NO. 6 •DECEMBER 2019

Do Investors Value Sustainability? A Natural

Experiment Examining Ranking and Fund Flows

SAMUEL M. HARTZMARK and ABIGAIL B. SUSSMAN∗

ABSTRACT

Examining a shock to the salience of the sustainability of the U.S. mutual fund

market, we present causal evidence that investors marketwide value sustainability:

being categorized as low sustainability resulted in net outflows of more than $12

billion while being categorized as high sustainability led to net inflows of more than

$24 billion. Experimental evidence suggests that sustainability is viewed as positively

predicting future performance, but we do not find evidence that high-sustainability

funds outperform low-sustainability funds. The evidence is consistent with positive

affect influencing expectations of sustainable fund performance and nonpecuniary

motives influencing investment decisions.

AS FIRMS INVEST MORE RESOURCES in sustainable and socially responsible en-

deavors, it is important to know whether such investments reflect investors’

preferences marketwide. Some investors will believe that an increase in re-

sources directed toward 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 pursue goals beyond simple

value maximization. Others still will value such investments not because they

care about the environment per se, but because they view such investments

as a sound way to maximize profits. Finally, some investors will be unaware

∗Samuel M. Hartzmark and Abigail B. Sussman are with the University of Chicago Booth

School of Business. We are grateful to Jonathan Berk, Anat Bracha, Alex Edmans, Max Farrell,

Mariassunta Giannetti, Matti Keloharju, Karl Lins, VikasMehrotra, Sanjog Misra, Giovanna Nico-

dano, Jacopo Ponticelli, Antonino Rizzo, Brad Shapiro, David Solomon, Kelly Shue, Paul Smeets,

Oleg Urminksy, and Eric Zwick, as well as to seminar participants at Aalto, Emory, Cambridge,

Chicago Booth, Warwick, London School of Economics, Imperial College, Northwestern, Bernstein

Quantitative Finance Conference, Boulder Summer Conference on Financial Decision Making,

UVA Darden Symposium on Mutual Funds and ETFs, Harvard Global Corporate Governance

Colloquia, Development Bank of Japan Conference, Texas Finance Festival, European Finance

Association Conference, Global Research Alliance for Sustainable Finance Conference, Swedish

House of Finance Conference on Sustainable Finance, and Research Affiliates Investment Re-

search Retreat for comments. We thank Halley Bayer, Nicholas Herzog, and Nathaniel Posner

for excellent research assistance. We thank Ray Sin, Steve Wendel, and Sara Newcomb at Morn-

ingstar for providing the data. This work is supported by the True North Communications, Inc.

Faculty Research Fund at the University of Chicago Booth School of Business. Sussman is a mem-

ber of the Morningstar Behavioral Science Advisory Board. The authors have nothing further to

disclose with respect to the Journal of Finance’s Submission Guidelines and Conflict of Interest

Disclosure Policy.

DOI: 10.1111/jofi.12841

C2019 the American Finance Association

2789

2790 The Journal of Finance R

whether a firm is investing in sustainability or will not care. While the market

surely contains examples of each of these investors, it remains unclear which

type represents the average investor and thus whether investments in sus-

tainability are consistent with what investors want. Put simply, do investors

collectively view sustainability as a positive, negative, or neutral attribute of

a company?

In this paper, we demonstrate that the universe of mutual fund investors in

the United States collectively puts a positive value on sustainability by pro-

viding causal evidence that marketwide demand for funds varies as a function

of their sustainability ratings. Addressing this question directly is difficult in

most settings, as it is not clear how to identify the preferences of the average

investor. Analysis of investment products with an explicit sustainability focus

reflects the preferences only of the subset of investors holding those products,

and hence does not speak to the average preferences of all investors in the mar-

ket. Furthermore, market outcomes, such as prices, related to firm attributes,

such as sustainability, are usually studied in equilibrium, where analysis is

inherently indirect.

We circumvent these challenges by examining a novel natural experiment

whereby the salience of the sustainability of over $8 trillion in mutual fund

assets experienced a large shock. Sustainability went from being difficult to

understand to being clearly displayed by one of the leading financial research

websites, Morningstar. In March of 2016, Morningstar first published sustain-

ability ratings, with more than 20,000 mutual funds ranked on a percentile

basis and given a globe rating based on their holdings. The worst 10% of funds

were rated one globe (low sustainability), while the best 10% were rated five

globes (high sustainability). Prior to this publication, there was not an easy

way for investors to judge the sustainability of most mutual funds without

considerable effort.

Figure 1illustrates the main finding of the paper: mutual fund investors

collectively treat sustainability as a positive fund attribute, allocating more

money to funds ranked five globes and less money to funds ranked one globe.

Moderate ratings of two, three, or four globes do not significantly affect fund

flows. The dashed vertical line corresponds to the initial publication of the

sustainability ratings. To the left of the line, fund flows after controlling for

monthly fixed effects are accumulated over the nine months prior to the rat-

ing publication; to the right of the line, fund flows are accumulated for the 11

months post-publication. The navy line represents five-globe funds, the ma-

roon line one-globe funds, and the gray line those rated in the middle (two- to

four-globe funds). Prior to the rating publication, funds received similar levels

of flows. After the publication, funds rated highest in terms of sustainability

experienced substantial inflows of roughly 4% of fund size over the next 11

months. In contrast, funds rated lowest in sustainability experienced outflows

of about 6% of fund size. We estimate that over the 11 months after the sustain-

ability ratings were first published, between 12 and 15 billion dollars in assets

left one-globe funds and between 24 and 32 billion dollars in assets entered

five-globe funds as a result of their globe rating.

Do Investors Value Sustainability? 2791

-6 -3 0 3 6

Fund Flows (%)

2015m6 2015m9 2015m12 2016m3 2016m6 2016m9 2016m12

Low Sustainability Avg Sustainability High Sustainability

Figure 1. Cumulative fund flows by sustainability rating. Estimates are accumulated from

a local linear plot of monthly flows after removing year-by-month fixed effects for nine months

before and 11 months after rating publication (denoted by the dashed vertical line). Shaded areas

indicate the 90% confidence interval. (Color figure can be viewed at wileyonlinelibrary.com)

Our experiment is rare in financial markets in that it examines a large

quasi-exogenous shock, equivalent to approximately 40% of NYSE market cap,

which does not directly impact fundamentals. The shock yields a measure of

sustainability by simply repackaging publicly available information in a way

that attracts attention and is easy to process. Further, construction of the mea-

sure is based on within-category comparisons that rely on Morningstar’s own

classification of funds, so it is unlikely to be highly correlated with investment

style or other general measures of sustainability.1The response we document

is therefore a response to the rating itself, not to new information about fund

fundamentals. In addition, examining mutual funds rather than individual

stocks allows us to directly observe fund flows. This allows us to avoid focusing

on indirect measures, such as prices, which suffer from the joint hypothesis

problem that they could be capturing risk.

This shock allows us to identify the causal impact of the globe rating along a

variety of margins. If funds were systematically different before the publication

of the ratings, then flows could be reflecting this difference. Figure 1suggests

that this is not the case, as do a variety of robustness checks including a

matching exercise on pre-publication characteristics and a placebo test.

While the globes are a discrete rating system of five categories, Morningstar

also releases each fund’s sustainability score and the percentile ranks under-

lying the ratings. If investors responded to the five-globe rating system rather

1Put another way, Barron’s noted that funds rated as having high sustainability by Morn-

ingstar were not “whom you’d associate with even a faint whiff of patchouli.” See http://www.

barrons.com/articles/the-top-200-sustainable-mutual-funds-1475903728.