DP13599 Low-carbon mutual funds

Author(s): Marco Ceccarelli, Stefano Ramelli, Alexander F Wagner
Publication Date: March 2019
Date Revised: May 2022
Keyword(s): behavioral finance, climate change, eco-labels, investor preferences, Mutual funds, Sustainable Finance
JEL(s): D03, G02, G12, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13599

Climate change poses new challenges for portfolio management. Investors face a trade-off between minimizing climate risk exposure and maximizing the risk benefits of portfolio diversification in a not-yet-low-carbon world. This paper investigates investors' and financial intermediaries' responses to this risk-risk trade-off. We analyze the fund flows and position changes of a large sample of European and US mutual funds after the release of Morningstar's carbon risk metrics in April 2018, a shock to the availability of information on climate transition risks. Funds labeled as "low carbon" experienced a significant increase in investor demand, especially those compensating for their under-diversification with high risk-adjusted returns. Fund managers actively reduced their exposure to high-carbon risk firms, especially when less costly for portfolio diversification. These findings shed light on whether and how climate-related information can re-orient capital flows in a low-carbon direction.