Does ESG Information Affect Individual Investors’ Portfolio Choices?

Socially responsible investing (SRI) involves considering environmental, social, and governance (ESG) issues when picking stocks.  Once a niche area of fund management, the volume of global sustainable investment in five major markets reached $35.3 trillion at the start of 2020, a 54.5 percent increase since 2016 and 35.9 percent of total assets under management.  Assets in sustainable investment products in Europe are expected to outnumber conventional funds as investors’ growing focus on material risks, including climate change and social inequality, pushes these strategies into the mainstream.  In the U.S., more than eight in 10 individual investors (85 percent) express interest in sustainable investing, while half have already made at least one sustainable investment.

As SRI has gone mainstream the need for timely and accurate ESG information has grown.  Large financial firms such as Merrill Lynch, Morgan Stanley, and UBS have started sustainable-investing platforms for their advisers, and they and others are increasingly relying on commercially available ESG data and ratings to gauge companies’ ESG performance.  Only a fraction of this ESG information about individual companies reaches retail investors, however.

Retail investors are nonetheless participating in the capital markets in increasing numbers, and so it is important to understand how they respond to ESG information.  Retail investors’ share of total equities trading volume in the U.S. is approaching 25 percent, up from 20 percent in 2020 and 10-15 percent in the preceding decade, and a survey conducted by the Financial Industry Regulatory Authority found that, despite a broad desire for socially responsible or sustainable investments, many of these investors don’t make such investments because they know little about ESG.

Prior research suggests that firms that disclose ESG information can attract investors with a taste for socially responsible activities.  Those investors can have a big impact on the mix of a company’s investor base and customers, which in turn can affect a company’s value by lowering its capital constraints and cost of capital and changing its future operating decisions.  Most of the research supporting this impact, though, has focused on institutional investors.  The evidence on how retail investors translate ESG information into portfolio choices is limited to studies of mutual fund flows and experimental studies of certain types of corporate social responsibility activity.

To investigate how retail investors translate ESG information into portfolio choices, we design a computerized asset-market experiment that mimics a real-world trading environment.  Participants were recruited using the online platform Prolific.  The sample consists of 584 U.S. citizens above the age of 18.  The experiment was followed by a questionnaire, which was constructed with the help of Unipark.

The sample is randomly split into nine groups, each comprising approximately 65 participants.  The groups are organized along two axes: the ESG dimension and the degree of information provided to participants.  Participants can trade four stocks of comparable firms with fixed expected-return distributions from the same industry.  The average expected returns differ across the four stocks, and the volatilities are held constant to differentiate participants’ preferences towards ESG from their attitudes towards risk.  These parameters remain constant throughout the experiment and are not shared with the participants.  While Group 1 does not receive any ESG information and thus serves as the control group, the remaining eight groups are given ESG information.  Participants allocate their funds upon receiving ESG information.  With this setting, we can control (i) the type, intensity, and form of ESG-related information disclosed to participants and (ii) the risk and return characteristics of the financial assets to which the ESG information is attached.

We find an economically meaningful difference in participants’ response to ESG information. There is a significantly higher portfolio reallocation in response to the release of ESG information in the order of 11 percentage points compared with the control group.  We find a similar difference when we study the three dimensions of ESG separately.  The social dimension leads to a lower portfolio allocation in the order of 9 percentage points, which, however, fails to translate into a statistically significant difference compared with environmental and governance-related information.  Next, we study whether the degree of detail in ESG information matters for portfolio decisions.  We find no significant relationship between the higher granularity of ESG information on stocks and portfolio allocations towards such stocks.  We then analyze whether participants’ personal characteristics drive their portfolio reallocation decisions in response to ESG information and use demographics, financial literacy and experience, personality traits, and ESG awareness as potential covariates.  In contrast to survey-based evidence on the importance of socio-demographic characteristics, we find that greater investment experience, age, and education negatively correlate with portfolio reallocations in response to ESG information.

This post comes to us from Catharina Janz, Rainer Michael Rilke, and B. Burcin Yurtoglu at WHU – Otto Beisheim School of Management, Germany. It is based on their recent paper “Does ESG Information Impact Individual Investors’ Portfolio Choices? – Evidence from an Experiment”, available here.