The Vanishing Difference Between ESG and Conventional Funds

Research based on Morningstar’s “globe” ratings, which measure a fund’s adherence to environmental, social and governance (ESG) standards, shows that most conventional funds indeed prioritize sustainability in their mandates, and that highly rated, five-globe funds don’t perform any better than one-globe funds.

Over the past decade, and particularly over the last several years, there has been a dramatic increase in ESG investing strategies. In fact, ESG investing (also known as sustainable investing or socially responsible [SR] investing) now accounts for more than one-fourth of total assets under management (AUM) in the U.S., with AUM growing to $12 trillion, up 38% from the start of 2016 to the start of 2018. Total assets in sustainable investing exceeded $30 trillion globally at the start of 2018, with institutions accounting for 75% of the total.

Increased investor interest has not only led to cash inflows but to heightened interest in research on ESG investment strategies. Harshini Shanker contributes to the literature with her December 2019 study, Social Preferences of Investors and Sustainable Investing. Shanker sought answers to questions such as: “Are sustainable investments the exclusive territory of a small set of so-called socially responsible mutual funds, or do conventional funds also prioritize sustainability? Are socially responsible fund portfolios more sustainable than conventional fund portfolios? Does the conventional investor in the market have social preferences? Are his preferences of a different nature than those of his socially responsible counterparts?”

To answer the questions, Shanker used Morningstar sustainability ratings, which are available on more than 20,000 mutual funds. Morningstar assigns each fund a “globe” rating ranging from one to five, with five being the most sustainable. The worst 10% and best 10% of funds receive one and five globes, respectively. Morningstar categorizes a fund as socially conscious if the fund declares a non-economic investment objective in its prospectus.