Tilting the wrong firms? Sustainable investing in transitioning firms

Abstract

This paper examines the role of sustainable transition phases in assessing the impact of portfolio tilting on firms’ sustainable performance. Sustainable investors increasingly reallocate portfolios to bridge a 4$ trillion annual funding gap needed for a sustainable economic transition, yet the effectiveness of this strategy remains an open question. We argue that firms undergo gradual transitions due to capital adjustment costs and technological development, making short-term metrics insufficient for evaluating the impact of tilting. Using granular ESG data from 9,130 firms across 77 countries, we develop sustainable aspirations and performance measures to identify firms early in their transition phase. We find sustainable investors tilt portfolios toward these firms, reducing their capital costs, encouraging them to set more ambitious aspirations, and enabling investment in green innovation. Firms are increasingly following through on such sustainable aspirations, particularly in greenhouse gas emissions and biodiversity. Our findings highlight portfolio tilting as a critical mechanism in financing the economy's sustainable transition.

Keywords: Portfolio tilting, socially responsible investing (SRI), firm commitments, esg, Environmental, Social, Governance, transition

JEL Classification: G11, M14, Q56