Investor interest in social responsibility has skyrocketed in the past three years, even as US regulations to hold companies accountable remain in flux and the environmental, social, and governance (ESG) label itself draws backlash.
Investors are willing to pay a premium for ESG index funds, and this premium has increased threefold over the period 2019 to 2022. Tapping burgeoning concerns around climate change, investors have also heeded ratings from respected research firms like Morningstar that lend credibility to the new category.
There's been tremendous growth and interest in ESG. And, if you calculate the value investors are willing to pay for ESG, it's gone up.
Fund investors were willing to pay up to 28 basis points, or 0.28 percent annually, more for funds with the ESG label, triple the 9-basis point premium they paid in 2019, finds new research from Harvard Business School professors Mark Egan, Malcolm Baker, and doctoral student Suproteem Sarkar in the working paper “How Do Investors Value ESG?” The financial stakes are rising: Bloomberg estimates that ESG assets may reach $53 trillion by 2025, or roughly one-third of global assets under management, the authors write.
“There's been tremendous growth and interest in ESG. And, if you calculate the value investors are willing to pay for ESG, it's gone up,” says Egan, the Mark Kingdon Associate Professor of Business Administration at HBS. “There's also geographic variation in the availability and willingness to pay for ESG funds. It lines up closely with concerns about the environment and climate change.”
Yet, ESG scores remain “notoriously unreliable,” the authors contend. Investors are waiting for the US Securities and Exchange Commission to finalize company ESG disclosure rules amid corporate pushback, so the working paper’s analysis comes at a critical moment for the category.
“What our paper would suggest is that uniformity in ratings, and possibly regulation by the SEC, is important, because investors increasingly assign value to ESG mandates,” Egan says. “Making sure these specialized funds and their underlying investments are held to account to deliver on their promises becomes all the more important as investors increasingly respond to ESG labels.”
Digging into 401k plans
To gauge just where investors are most willing to pay for ESG-linked versus non-ESG funds, the researchers examined data for more than 55,000 US 401(k) plans, ferreting out funds that include at least one investment option with an ESG mandate.
Using data from the Center for Research in Security Prices, the authors studied funds with month-by-month ESG ratings data from Morningstar, which measures company-level sustainability risks and opportunities. They also examined data from Refinitiv, another widely used ratings firm, and found similar patterns.
On average, over the whole period, the researchers estimate investors were willing to pay 20 basis points, or 0.2 percent, more for the ESG label, expecting better returns from funds with the designation, whether financial or behavioral, the authors write, calling the figure conservative. After accounting for differences in fund portfolios, the researchers find that investors are willing to pay up to 63 basis points, or 0.63 percent, more for ESG funds.
Where investors live—and who they work for—also matters
People who live in US counties where the population in 2019 showed concern about climate change are willing to pay on average 37 basis points more for ESG funds than those who live where people care less about climate issues, where investors won’t pay a premium at all, the authors discovered. That map closely mirrors US political maps for Republican and Democratic counties, the authors find, using county-level election results data.
Investors in counties where concern runs high about climate change also have a larger number of ESG-labeled funds to choose from, the authors note.
The industry in which 401(k) investors work also comes into play: Educators and information technology workers were, on average, willing to pay more for ESG-focused funds and chose at least one ESG-focused fund as part of their 401(k). The average transportation sector employee put no value on the ESG label, according to the research.
What accounts for the higher interest in ESG funds? While the authors do not have a definitive answer, they note that part of the interest may come from financial motives; investors may believe that ESG funds will deliver higher returns than non-ESG funds—or from non-financial motives; investors may believe that ESG investing benefits society.
What matters to ESG investors
The authors note that, while investors are willing to pay a 20-basis point premium, or 0.2 percent, more for ESG funds, ESG funds are typically only 5 basis points, or 0.05 percent, more expensive than non-ESG funds. This suggests that investors, rather than mutual fund companies, capture most of the benefits of ESG investing. The research also suggests that:
Investors trust ratings, to a degree. Ratings from a trusted firm like Morningstar count in the eyes of investors.
Investors appear to be discerning as to what the portfolio holds. They care that funds that rank better in terms of other ESG metrics.
“It isn’t just the ESG label. Morningstar ratings matter,” Egan says. “Investors appear to be discerning as to what the portfolio holds. They care that funds that rank better in terms of other ESG metrics. But, the label itself still counts over and above the underlying score of the fund portfolio.”
Clean energy counts. While ESG covers a broad set of issues, the authors find that investors are particularly concerned about fossil fuels. Investors prefer and are willing to pay a premium for funds with low fossil fuel exposure and low carbon emissions.
“So, we think investors like ESG. What does that actually mean? Are they willing to put their money where their mouth is? We find that they are,” Egan says. “It's not a crazy amount of money that they're willing to pay for ESG—but it's not meaningless, either.”
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Image: iStockphoto/SimonSkafar
