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Fundies don’t believe in ESG (when they run their own money)

Having "skin in the game" is usually a boon for performance and client alignment. But when managers put their money where their mouth is, they don't invest it sustainably according to a Swiss report.

In funds management, having ‘skin in the game’ by mingling employee money with external money can create better alignment between clients and management and is also correlated with higher performance. But it’s also correlated with lower future fund sustainability performance according to the findings of “Revealed Beliefs about Responsible Investing: Evidence from Mutual Fund Managers“, a paper from the Swiss Finance Institute penned by Vitaly Orlov, Stefano Ramelli, and Alexander F. Wagner.

“Managers opt for less ESG-oriented firms following increases in managerial ownership, whereas reductions in fund managers’ stakes lead to positive changes in portfolio sustainability metrics,” the authors write. “In addition, we find that managers who co-invest tend to overweight stocks with severe ESG issues in their portfolios and allocate less capital to stocks with no controversies.”

The authors analysed 1,273 funds managed by 2,616 unique managers from January 2015 through to December 2020, and hand-collected information on ownership from funds’ Statements of Additional Information, obtained from the SEC’s EDGAR database.

The authors looked only at funds that follow a diversified strategy in which managers are unrestricted in their exposure to ESG factors, excluding funds that commit to following sustainable or socially responsible investing practices.

The findings of the study have two practical implications, the authors write. First, they raise concerns about the marketing of sustainable investment strategies as a way to attain superior financial performance, and investors should be cautious in “blindly accepting” a business case for sustainability that managers “on average do not seem to believe”.

“Of course, ESG strategies may or may not pay off in the long run regardless of fund managers’ beliefs, which may be distorted or myopic,” the authors write. “For instance, Cheng, Raina, and Xiong (2014) show that U.S. securitization agents did not anticipate the 2007 housing market crash even in their own personal home transactions with significant personal wealth at stake.”

The second practical implication is that the results are also relevant for investors committed to sustainable investing who might be willing to give up some performance in the short term to reward firms with good ESG practices.

“When fund managers do not share the same commitment and/or beliefs, their co-investment in the funds may paradoxically create a misalignment of interests in which investors’ sustainability preferences are overlooked,” the authors write.

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