Four Facts About ESG Beliefs and Investor Portfolios

Stephen Utkus is Visiting Scholar at Wharton Business School at the University of Pennsylvania and Fellow at the Center for Financial Markets and Policy at Georgetown University. This post is based on a recent paper by Mr. Utkus; Stefano Giglio, Professor of Finance at Yale School of Management; Matteo Maggiori, Associate Professor of Finance at Stanford University Graduate School of Business; Johannes Stroebel, David S. Loeb Professor of Finance at NYU Stern School of Business; Zhenhao Ta, Pre-Doctoral Fellow at Yale School of Management; and Xiao Xu, Investment Strategist at Vanguard. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian Bebchuk and Roberto Tallarita; How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli-Katz; Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee (discussed on the Forum here) by Max M. Schanzenbach and Robert H. Sitkoff; and Exit vs. Voice (discussed on the Forum here) by Eleonora Broccardo, Oliver Hart and Luigi Zingales. 

Over the past decade, environmental, social, and governance (ESG) investing has experienced significant growth. However, the motivations of retail investors for investing in ESG assets, including the relative importance of financial and non-financial considerations, are not well understood. To shed light on this topic, our paper, Four Facts About ESG Beliefs and Investor Portfolios, documents four facts about ESG investing among a large group of retail investors, using a novel panel data set that connects survey data on ESG beliefs with administrative data on investor portfolios.

Survey Description

The survey features three ESG-related questions. The first elicits investors’ long-run (10-year) return expectations from investing in diversified ESG stock portfolios. We compare these expectations to the same investors’ long-run expected returns for the overall stock market, which are also elicited in the survey. The second question investigates investors’ primary ESG investment motives: (i) no reason, (ii) excess financial returns, (iii) non-pecuniary ethical considerations, or (iv) hedging climate risks. A third question elicits investors’ level of concern about climate change.

The survey is administered by Vanguard, one of the world’s largest asset management firms, to its U.S.-based clients. In addition to the three ESG questions, the survey also elicits investors’ beliefs about stock returns, bond returns, and GDP growth. Participants are a random sample of Vanguard’s U.S.-based individual investor households, with 80% holding retail accounts and 20% holding retirement plan accounts. Overall, the sample of individuals who are potentially contacted represents about $2.5 trillion in assets at Vanguard. The original bi-monthly survey has been running since February 2017. The survey receives around 2,000 responses per wave, with many of them from re-respondents. A description of the original survey can be found in Giglio et al. (2021).

The ESG-related questions were added in June 2021, which appear at the end of the pre-existing survey. The survey is not branded as ESG-related. Our analysis includes ten (seven) waves containing the first two (three) ESG-related questions from June 2021 (December 2021) to December 2022. Investors in our sample are relatively wealthy, with an average (median) of total Vanguard portfolio value of about $689,000 ($398,000). About 65% of the respondents are male, and the average age is 63 years old.

Four Facts

Fact 1: On average, investors anticipate that ESG equities will return 1.4% per year less than the overall equity market over a 10-year period. This expectation may arise the belief that ESG stocks are overpriced, that their lower returns are an equilibrium outcome due to the hedging properties of ESG stocks against future climate disasters, or that they provide non-pecuniary benefits to ethically-motivated investors.

Fact 2: There is significant heterogeneity among investors in ESG return expectations and investment motives. The standard deviation of expected excess ESG returns is about 4%. Interestingly, beliefs about the relative returns of ESG investments do not correlate with beliefs about market returns, GDP growth, market disaster probabilities, or bond returns. This suggests that the large heterogeneity in beliefs about ESG returns represents a separate dimension of the investors’ beliefs relative to traditional variables that enter portfolio decision-making.  Differences across investor characteristics are relatively modest, though they do display some meaningful patterns: respondents who are younger, less wealthy, female, or living in areas with higher Democratic vote shares tend to be more optimistic about relative ESG returns. However, each of these groups on average still expects lower returns from ESG investment compared to the overall market.

As for investment motives, 45% of survey participants have no specific reason for ESG investment, 7% cite higher return expectations, 22% view ESG stocks as a hedge against climate risk, and 25% are motivated by ethical considerations. Investors with no apparent reason for ESG investment exhibit the most pessimistic long-term expected excess ESG returns, at -2.7% per year.

Although in our sample ESG holdings are modest – only about 4% of retail investors hold ESG investments, and a typical allocation among holders is less than 15% of risky assets – we are able identify several emerging relationships between ESG beliefs and portfolio holdings.

Fact 3: ESG beliefs are important drivers of actual portfolio allocation to ESG investments, and ESG portfolio holdings are increasing in expected excess ESG returns. The relation between ESG holdings and beliefs is stronger in the positive domain (i.e., among investors who expect ESG funds to outperform the market) versus weaker in the negative domain (i.e., among investors who expect underperformance), suggesting that challenges with shorting might play a role in determining retail investors’ ESG investments.

We also find a strong association between ESG holdings and reported motives for such investments. ESG holdings are the largest among investors with ethical ESG motives and high concerns about climate change. Approximately half of the investors who hold ESG assets report being primarily motivated by ethical considerations, and 80% of actual ESG investors report a high level of concern about climate risk.

Fact 4: Both pecuniary and non-pecuniary considerations jointly drive portfolio allocation to ESG. Financial considerations (expectation of excess ESG returns) are an important driver of ESG allocations for all groups of investors, including those who mention hedging or ethical motivations as key reasons for investing in ESG. At the same time, some morally motivated investors hold ESG investments even when they expect negative excess returns, showing that non-pecuniary considerations also play a role alongside financial performance.

The complete paper is available for download here.

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