When Investors Call for Climate Responsibility, How Do Mutual Funds Respond?

Abstract

In April 2018, the investment platform and financial advisor Morningstar introduced a new eco-label for mutual funds, the Low Carbon Designation (LCD). The unexpected release of this label induced responses by (1) investors and (2) mutual funds. First, investors flocked to funds labeled as Low Carbon. Through the end of 2018, such funds enjoyed a 3.1% increase in assets compared to otherwise similar funds. This effect was distinct from that of more generic sustainability ratings ("Globes"), and it reversed for funds that lost the label in August or November 2018. Second, managers of just-missing funds adjusted their holdings towards lower carbon risk and lower fossil fuel involvement, the two criteria used to assign the LCD. Both the rewards-for-LCD and the moving-towards LCD effects are stronger for European funds, retail funds, funds with weak financial performance, and low-sustainability funds. Overall, the findings suggest that financial intermediaries actively compete for flows driven by the increasing demand for climate-conscious investment products.

Keywords: behavioral finance, climate change, eco-labels, investor preferences, mutual funds, sustainable finance

JEL Classification: D03, G02, G12, G23