Assets under management with a sustainability focus have increased tremendously over the years. New EU regulation now requires investment advisors and managers to assess their retail clients’ sustainability preferences. However, sustainability preferences are difficult to define and interpret. Understanding more about how clients orientate their sustainability preferences and why they choose to invest in high ESG assets is crucial. During the Inquire Europe spring seminar Peiran Jiao from Maastricht University presented his research ‘Altruists going on an ego trip: Beliefs and ambiguity attitudes in socially responsible investment’ which addresses these issues.
For those who were unable to attend his presentation, a summary has been made:
“In 2014, one in nine dollars of AUM were involved in SRI, whereas in 2020 this number tripled to one in three dollars. Generally, this has been explained through two factors. The first is social preferences. People want to contribute to saving the environment or they wish to portray the image that they care about these types of issues. They are therefore willing to give up some level of financial performance in order to invest in accordance with their social preferences. The second reason is the consideration of financial performances; they expect a superior return or/and risk performance from high ESG investments.
These reasons are based on the beliefs that investors have towards ESG investments, but research shows that these beliefs have not been formally evaluated; and worse still, these beliefs can be systematically biased. On the one hand, those taking the financial consideration approach think wishfully and overstate the expected ESG fund return. On the other, those concerned with their image will understate the ESG fund return, as if financial returns are not the reason to why they invest in high ESG funds.
In this project we address this problem by using the adapted exchangeability method; what we get is a quantitative and incentivized measure of expectations, about risk and return.
Next, we also look at ambiguity attitudes of investors towards high and low ESG funds. Ambiguity is uncertainty with unknown probability distribution of future outcomes. People are ambiguity averse in general. Therefore, they may invest in assets with a high ESG label if they think the label can resolve ambiguity. For instance, one might think that a ESG label is associated with higher or lower results. On the other hand, the ESG label might actually increase ambiguity and make the task more difficult for retail investors; even in finance literature researchers are unsure whether high ESG investments will outperform low ESG investments.
What we find through our research is that adding a high ESG label leads to a higher expected return and lower expected risk, which is actually the opposite of what has been found using other methods. It also makes our experimental participants more conservative when updating on negative information, which means that their beliefs are more resilient to negative shocks. Finally, these participants are less ambiguity-averse towards investment returns when they know that a fund has a high ESG label; a high ESG rating can reduce investors’ perceived ambiguity in the investment.
Overall, we find evidence that investors are likely to understate the ESG financial performance to emphasize their social preference motives in unincentivized questionnaires. Thus, financial motives play an essential role in SRI decisions. Meanwhile, as an alternative explanation to ESG investing, a high ESG rating label can promote SRI by reducing the amount of perceived ambiguity associated with the asset.
This information is important for theorists, as it helps us determine why investors engage in SRI. Moreover, it can serve as a practical tool to assess retail investors’ ESG preferences. For example, funds can incorporate our tools to achieve precision marketing into client profiling, and to obtain a reliable measure of their clients’ beliefs and ambiguity attitudes in the ESG territory”.
Inquire Europe members can access the research and the presentation slides via: https://www.inquire-europe.org/event/joint-spring-seminar-2023/