Lightbulb and money planted in soil, ESG (Photo: Shutterstock)

Asset managers’ commitment to environmental, social and governance factors in their investment processes may be shakier than meets the eye, according to new research.

Soohun Kim at Georgia Institute of Technology and Aaron Yoon at Northwestern University used United Nations Principles for Responsible Investment to empirically assess how asset managers perform on their commitment to ESG investing.

PRI, a 2006 initiative by international institutional investors, calls for responsible investment and active ownership. PRI signatories commit to incorporating ESG issues into investment analyses and decision-making processes.

Kim and Yoon found that signatories experience a large fund inflow, 4.3% per quarter in the six quarters after signing, compared with the six months prior to signing.

This increase in fund flow happens regardless of prior ESG performance.

However, PRI funds on average do not exhibit improvements in fund-level ESG scores after signing.

The researchers used datasets from MSCI, Sustainalytics and TruValue Labs to determine whether signatory asset managers changed their portfolio holdings to incorporate ESG factors. Their analysis found that managers’ ESG scores were the same after they signed as they were before, regardless of the dataset used.

What about returns? Kim and Yoon found no increase. “We actually find that both return and alpha substantially decrease after signing and that this result is robust to controlling for fund size (i.e., diseconomies of scale).”

The researchers also examined signatory funds’ proxy voting behavior, and found that they were 30% more likely than their peers to remain silent on environmental issues and that their stock holdings subsequently experienced an increase in environment-related controversies.

“We find this interesting because environmental controversies have been documented to be tail risks that have significant negative implications to stock prices,” they write.

Kim and Yoon’s research showed that smaller, newer funds with higher historical alpha were likelier to sign PRI, but that only quant-driven and institution-only funds improved ESG after signing.

“Overall, our conclusion is that only select signatories make visible changes to ESG while most are using PRI as a mechanism to attract capital.”

The researchers write that their findings suggest asset managers need to clearly communicate their ESG execution or execute on ESG strategies as promised. “This is crucial because tremendous amount of wealth and resources are flowing into ESG.”