Environmental, Social, and Governance (ESG) investing has drawn a lot of attention over the past decade, but the extent to which institutional investors have altered their perspective on ESG, as evidenced by their voting and portfolio decisions, remains unclear. In a new paper, we attempt to identify ESG-invested assets under management (“AUM”) and its impact. We categorize mutual funds as ESG-oriented based on their names, their voting records on environmental and social (E&S) proposals, and their portfolio holdings. Although we focus on the E and S parts, we follow the standard terminology of referring to sustainability-linked funds as ESG funds.
First, we examine funds with sustainability-related terms in their names (i.e., ESG-by-name funds), for example, AXA Enterprise Socially Responsible Fund. These funds are growing throughout the sample. Nevertheless, they control only 0.7 percent of aggregate AUM as of 2021.
Our second measure of ESG classifies mutual funds based on their voting on E&S proposals (i.e., ESG-by-vote funds). Supporting E&S proposals is one of the most obvious ways for funds to reveal their ESG preferences; we classify funds as ESG-by-vote if they support the majority of E&S proposals they face in a given year. AUM of ESG-by-vote funds is also growing and reached 24.4 percent of aggregate AUM at the end of 2021, which is clearly greater than that for the first measure. Nevertheless, this higher relative-aggregate AUM does not translate into a significant number of E&S proposals passing; only 3 percent passed in the sample period.
Many industry professionals argue that ESG investing is demonstrated through portfolio filters. Therefore, we explore a third approach to categorize funds as ESG-focused based on their holdings. Specifically, we calculate the value-weighted ESG risk score (measured by RepRisk) of the companies in their portfolios each year and assign funds with below-median risk scores as ESG-by-hold funds. In the early years of the sample, funds employing ESG filters held less than 36 percent of the total AUM, gradually decreasing to 27 percent by 2021. This suggests that the proportion of assets attributed to funds implementing ESG filters actually decreased over time.
The total AUM of funds identified by any of the three approaches was about 30 percent at the end of 2021 (note that a single fund can potentially be identified by one, two, or all three methods). Thus, one key finding is that ESG-linked AUM is relatively small compared with the total AUM. However, ESG funds can have an impact if they hold concentrated positions. We investigate this possibility and find that it does not hold up; regardless of how we categorize them, ESG funds are generally smaller and have a greater number of positions compared with their non-ESG counterparts.
However, ESG funds can still have an impact through their influence on other funds within the same fund family. We investigate this possibility by asking, do non-ESG funds within a fund family exhibit an increased propensity to vote favorably for E&S proposals following the family’s introduction of an ESG fund? We find some evidence of spillover effects within fund families resulting from the inclusion of an ESG-focused fund. However, despite these effects, sibling funds continue to vote more against, rather than in favor of, E&S proposals.
Relatedly, we conduct a more detailed analysis of family voting patterns concerning E&S proposals. For any given proposal, a fund family could have multiple funds holding stock in the firm, each with varying numbers of votes based on their respective holdings. We examine the net effect of the family’s voting, indicating whether the total votes cast by the family for a specific shareholder proposal were in favor or against it. Our analysis reveals a consistent upward trend in the family-level voting score, demonstrating an increasing influence of ESG funds within fund families and a broader recognition of ESG preferences. However, the overall net family score has never been positive throughout the entire sample period, indicating that their overall stance on E&S proposals remains to vote against them.
As a counterfactual, we calculate the number of E&S proposals that would have been passed if all funds belonging to families that signed the United Nations Principles for Responsible Investing (UNPRI) had unconditionally supported all subsequent E&S proposals they voted on. Our analysis shows that if these funds had provided unconditional support, the voting outcome would have been reversed for a minimum of 496 E&S proposals, potentially increasing the passage rate of E&S proposals to 17.5 percent. Twenty-five percent of the proposals that would have passed are climate related.
To gain a deeper understanding of family voting patterns on E&S proposals, we further investigate measures of disagreement within fund families regarding proposal voting. Our analysis reveals that E&S proposals elicit significantly higher levels of disagreement within a family compared with other types of proposals. This disagreement arises when ESG funds vote in favor of the proposals, while other non-ESG funds, typically larger, vote against them. Consequently, the majority of E&S proposals end up failing to pass, and this holds true whether we look at all proposals or only material proposals.
Turning to holdings, we find that, across all types of funds, the ESG scores of firms added to portfolios are generally higher than those of firms that are dropped. However, despite these observations, the value-weighted scores of portfolios do not demonstrate any notable improvement over the sample period. This implies that the inclusion or exclusion of firms in portfolios does not significantly enhance the overall ESG scores on a value-weighted basis. Furthermore, we find that the risk scores of funds closely align with the overall market value-weighted risk score. This indicates that changes in portfolio risk profiles are likely attributed to the variations in the composition of available firms rather than binding active screening or selection by the funds themselves. In short, our findings suggest that, if ESG is being expressed through portfolio filters, these filters are rarely restrictive or binding.
Though much of the ESG debate in the past decade centered on the conflict between investors focused on financial return and those with strong ESG preferences, our results suggest that this conflict is overblown, with a lot of mere talk about ESG. Overall, our findings suggest that the effects of ESG investing are growing but remain relatively limited. E&S proposals rarely pass, and the ESG scores of funds declaring ESG preferences are not that different from the rest of funds.
This post comes to us from Abed El Karim Farroukh at Indiana University’s Kelley School of Business, Jarrad Harford at the University of Washington, and David (Dongheon) Shin at the University of Oklahoma’s Michael F. Price College of Business. It is based on their recent article, “What Does ESG Investing Mean and Does It Matter Yet?” available here.