VoxEU Column COVID-19 Financial Markets

Sustainability preferences under stress: Mutual fund flows during COVID-19

Socially responsible investing has been at the centre of recent regulatory scrutiny and academic debate. This column explores how retail investors’ preferences for socially responsible investments respond to market distress, as revealed within mutual fund flows during the COVID-19 pandemic. The results suggest that funds with the highest sustainability ratings experience sharper declines in flows. This suggests that there tends to be a shift away from sustainability among retail investors’ preferences in the face of an economic shock, highlighting a source of fragility in the increasingly popular socially responsible investment  market. 

Socially responsible investing (often known as SRI or ESG investing) has been one of the fastest growing areas in the asset management industry, attracting greater than average flows from mutual fund investors over the past several years (Hartzmark and Sussman 2019). This trend has also raised regulatory scrutiny, triggering SEC investigations into US SRI funds. It is no surprise that recent research has increasingly focused on understanding investor preferences for sustainable investments and their performance. While much of the current understanding of investor preference for socially responsible assets is still in its infancy, particularly little is known about its behaviour during market downturns and recessions, partly due to the short history of its buoyancy. Does socially responsible investing represent a resilient demand for necessities? Or does it reflect a luxury demand that eventually weakens when the going gets tough?

Retail socially responsible investment fund flows during COVID-19

In our recent study (Döttling and Kim 2020), we aim to contribute to this important debate by investigating the fragility (or ‘sustainability’) of the preference for socially responsible investments as revealed by retail mutual fund flows in the face of the large economic shock brought about by COVID-19.

The outbreak of the novel coronavirus, and the subsequent stock market crash and economic crisis that began in February 2020, provides an ideal setting in which to study the impact of a sharp and unexpected deterioration in economic and market conditions on retail mutual fund flows. The COVID-19 shock is particularly meaningful as a laboratory to study preferences for sustainable investments, as it has triggered the first major crisis of its magnitude since the upsurge in sustainable investing. Using this shock, we study the response of investments by retail investors in sustainable mutual funds as a measure of ‘revealed preference’ for sustainability. This is motivated by previous findings that retail investors actively reallocate capital across different funds and are reactive to shifts in sentiment and preferences (Frazzini and Lamont 2008, Ben-Rephael et al. 2012, Wang and Young 2020). Retail investors are also economically important, dominating the mutual fund space in terms of total net assets (i.e. over 61% of aggregate net assets).

Using weekly retail fund flow and the sustainability rating data for US domiciled open-end equity mutual funds from Morningstar, we find that retail investor preference for sustainability significantly weakens under economic and market stress. While funds with ‘five-globe’ Morningstar sustainability ratings (i.e. ‘high ESG’ funds) receive higher than average weekly retail fund flows prior to the COVID-19 crisis (consistent with Hartzmark and Sussman (2019) and Ceccarelli et al. (2020)), these flows disappear after the onset of the pandemic-induced market crash. Moreover, this shift in flow persists into the weeks from 28 March to 25 April 2020, when the market rebounded dramatically after the US stimulus package was announced. This main result is illustrated in Figure 1, where we plot weekly average retail fund flows over the sample period (04 January to 25 April 2020) for funds with different sustainability ratings. Relative to pre-COVID levels, the weekly flow into ‘high ESG’ funds dropped by 0.2 percentage points more than that of ‘average’ funds.

Figure 1 Weekly average retail fund flows by sustainability rating 

Institutional socially responsible investment fund flows do not decline

We interpret this key result as indicating shifts in investor preference away from sustainable investments in the face of financial and economic stress. Importantly, we contrast our main results based on retail flows with those based on institutional flows, in order to shed light on why such a shift may have occurred. Differences between mutual fund investment behaviour by retail and institutional investors provide important clues to explain the retail flow responses. For example, institutional share classes of mutual funds are sold with high minimum investment requirements (e.g. $200,000 or more). They are also sold to institutional investors who are more sophisticated and less financially constrained. Moreover, institutional investors are likely to have strong ‘ESG mandates’ built into their charters and perform ‘ESG shareholder engagements’ as part of their core strategies (Gibson et al. 2020, Krueger et al. 2020, Hoepner et al. 2020). Crucially, such investors are less likely to shift flows away from sustainable investments in response to market signals (Cao et al. 2018).

If socially responsible investing is to be viewed as a ‘non-essential’ good, one would expect granular cash-strapped retail investors to cut spending on such investments more sharply in bad times compared to deep-pocketed and committed institutions. Consistent with this idea, we find that institutional flows into ‘high ESG’ funds do not show sharp reductions in response to the COVID-19 shock, in contrast to retail flows. This result is illustrated in Figure 2, where we plot weekly average institutional fund flows, analogous to Figure 1. In fact, we find that institutional flows drop sharply but temporarily during the early crash period, and only for ‘low ESG’ funds. These results indicate that our evidence on retail flows are consistent with a shift away from sustainability preference – a perceived luxury good that retail investors no longer find affordable under financial stress.

Figure 2 Weekly average institutional fund flows by sustainability rating

Individual preferences shift away from sustainability

This interpretation is also supported by evidence of internet search traffic shifting away from topics related to sustainability to topics related to the economy, consistent with our hypothesis (see Figure 3). Using a host of additional tests, explicit control variables, and a rich combination of fixed effects, we further exclude potential alternative explanations based on confounding factors such as fund style, age, size, expense ratios, past returns, risk-adjusted past returns, past flows, Morningstar star ratings, common trends, ‘buying the dip’ behaviour, or changes in risk tolerance. Overall, we find our evidence consistent with non-financial motivations for sustainable investments by retail investors that are adversely impacted by a large economic shock.

Figure 3 Google search trends

a. Sustainability topics

b. Financial and economic topics


Our results highlight a source of fragility in the demand for socially responsible investments, stemming from retail investors. A long-term implication of our study is a potentially broader shift in investor preferences under prolonged economic distress. This is due to potential externalities from retail flows that may affect institutional motivation, therefore impeding the efficacy of institutional ESG ownership and engagement. This column contributes to the idea that to make socially responsible investing sustainable, it must be clear that sustainability creates tangible financial and economic value. And if so, this needs to be communicated to retail investors. Leaning on social signals and preferences will only help the funds get so far.

Our study is closely related to the growing body of research on socially responsible investments in mutual funds that has evolved around the debate on whether sustainable investment flows are driven by financial or non-pecuniary objectives (Bollen 2007, Renneboog et al. 2011, Riedl and Smeets 2017, Hartzmark and Sussman 2019, Ceccarelli et al. 2020). We contribute to this line of work by highlighting the importance of market stress and economic uncertainty in the sustainability of preferences for socially responsible investing. We also complement contemporaneous work by Pastor and Vorsatz (2020), who demonstrate that active fund investors continue to value sustainability even after the COVID-19 shock, by emphasizing the implications of important investor heterogeneity (namely that retail investor preferences for sustainability behave distinctly from institutional preferences).

Our work also contributes to research on corporate social responsibility, which has highlighted the role of social capital in mitigating firm downside risk (Lins et al. 2017, Albuquerque et al. 2019). In particular, a number of recent studies document that stocks of firms with higher ESG ratings and corporate social responsibility activities experience relatively less negative returns during the COVID-19 market crash (Albuquerque et al. 2020, Ding et al. 2020). Building on these findings, our results can be interpreted as an investor preference channel that is driven by a shift in taste. Our results also highlight the non-pecuniary motives for sustainable investing by retail investors and their responses to constraints imposed by market stress and uncertainty.

Finally, our study provides a stepping stone to understanding investor preferences for sustainable investments. Our work underscores the importance of studies of optimal socially responsible investing systems under scarce socially responsible capital, heterogeneous investors, and time-varying preferences (Pastor et al. 2020, Pedersen et al. 2020, Oehmke and Opp 2020, Humphrey et al. 2020).


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