Working Paper: CEPR ID: DP15945
Authors: Nickolay Gantchev; Mariassunta Giannetti; Rachel Li
Abstract: We show that following the introduction of Morningstar’s sustainability ratings (the “globe” ratings), mutual funds attempt to improve their globe ratings by increasing their demand for sustainable stocks. This trading behavior creates buying pressure, making stocks with high sustainability ratings overvalued. As a consequence, a tradeoff between sustainability and performance arises and the performance of funds improving their globe ratings deteriorates. As performance appears to be more important in attracting flows than sustainability, a new equilibrium emerges in which the globe ratings stop affecting investor flows and funds no longer trade to improve their globe ratings. Our results highlight the issues arising when funds are evaluated along two different dimensions that create conflicting incentives for fund managers competing for flows.
Keywords: sustainability; ESG; mutual funds; fund flows; ratings
JEL Codes: G11; G12; G23; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| introduction of globe ratings (F01) | increase in demand for sustainable stocks (Q01) |
| increase in demand for sustainable stocks (Q01) | overvaluation of high sustainability-rated stocks (G19) |
| overvaluation of high sustainability-rated stocks (G19) | negatively affects future performance (D29) |
| tradeoff between sustainability and performance ratings (Q56) | influences fund managers' incentives (G23) |
| improving globe ratings (F01) | deterioration in performance (D29) |
| new equilibrium emerges (D59) | globe ratings cease to affect investor flows (F21) |