Institutional Investors and ESG Preferences

Abstract

We study the effect of environmental, social and governance (ESG) scores on the portfolio allocations of institutional investors. Using a unique data set, we find that institutional investor holdings (as measured by 13F filings) are strongly driven by the ESG quality of companies. While investors are driven to add high quality ESG companies to their portfolios, there is a negative relationship to ESG when it comes to taking large ownership stakes. Blockholders appear much less motivated by ESG scores. Evaluating individual ESG scores, we find that the individual ESG governance score has the highest impact on institutional investor holdings, while E scores have the most negative effect. This is explained by risk and return measures. Higher E scores are correlated with negative alpha indicating such securities are overbought. Meanwhile G scores have a strong correlation with higher Sharpe ratios, indicating a more favorable risk-reward profile; G scores also indicate lower betas and therefore less exposure to systemic risk. The Bloomberg disclosure based
ESG scores are more significant determinants of investor holdings and risk-return measures than the subjective Sustainalytics ratings – suggesting that disclosure is the more important determinant for investors.

Keywords: ESG, Sustainable Finance, Institutional Investors, Financial Performance, Disclosure

JEL Classification: G12, G14, G15, G23, G32, M1