While institutional appetite for ESG investments — stocks in particular — has soared over the past decade, new research finds that the increased demand has less to do with a desire for social and environmental impact and more to do with trend-chasing, following the herd, and playing it safe.
In their paper, "ESG Mania and Institutional Investments," finance professors Riza Demirer (from Southern Illinois University Edwardsville) and Huacheng Zhang (University of Edinburgh) examines the two primary motives for ESG investing: "Impact-chasing," where investors sincerely aim to change corporate behavior; and "impact-washing," where the ESG label is used primarily for marketing and reputation management.
“We do not find consistent evidence that institutions are sincerely impact-chasing,” the authors write. “Instead, we find consistent evidence that institutional ESG investments are mainly driven by fad, reputation concern and fund flow, suggesting that institutions are more likely impact-washing.”
Although interest has plateaued recently, increased environmental and social concerns fueled a boom in ESG investments over the last decade, which in turn led to a substantial rise in the value of companies that made progress on these factors. The number of asset managers signing on to the UN’s Principles of Responsible Investment reached 2,450, representing $80 trillion of assets in 2019 (up from 63 with $6.5 trillion in AUM in 2006). Global inflows into ESG offerings have recently dropped.
Investors have collectively rushed into the popular assets. The study found this copycat behavior is universal, happening regardless of a company's actual ESG score, the size of the investor, or prevailing market conditions.
The research also notes that this institutional ESG herding hasn’t driven up firms’ ESG engagement — nor has it reduced the cost of capital. Plus, institutions that have chased these haven’t outperformed their peers. Further analysis suggests that the essential motivators for ESG herding is “reputational concern and attracting fund flow.”
Professors Demirer and Zhang found that whether ESG investing helps achieve sustainability goals is broadly inconclusive. On one hand, studies show that pursuing ESG goals can be expensive, and the associated economic losses may deter impact-chasing investments. On the other, sincere investors may be willing to bear economic losses to chase ESG impact.
