Sustainability Preferences Under Stress: Evidence from Mutual Fund Flows During COVID-19

Abstract

We investigate investor ESG preferences during economic distress revealed by US retail mutual fund flows. Using the COVID-19 pandemic as an unexpected shock to the economy, we show that "high ESG" funds with five-globe Morningstar sustainability ratings - which receive higher than average fund flows during normal times - experience a sharper decline in flows compared to other funds during the crisis. Consequently, high and low ESG fund flows converge as a percentage of assets under management. This effect is significant not only during the market crash weeks between February 22 and March 21, but also during the post-stimulus recovery weeks between March 28 and April 25. The results are not driven by style, time effects, fund size or age, star ratings, past returns, or investors buying the dip during the crash. Based on markedly different responses by institutional fund flows, our results are consistent with a shift in sustainability preference among retail investors under economic distress. We corroborate our findings with an inspection of internet search traffic data that shows falling interest in sustainability topics during the pandemic, as well as sample extensions covering non-US funds and state reopening periods. Our study highlights retail ESG fund flows as a potential source of fragility for sustainable investing.

Keywords: COVID-19, Mutual Fund Flows, Sustainable Investing, ESG, SRI

JEL Classification: D62, G11, G14, G23, G41, I10, M14