Sorting ETFs and mutual funds into appropriate sectors and allocations can be challenging for investors, even with abundant information. When evaluating environmental, social, and governance (ESG) investments, the difficulty is compounded by inconsistent labeling practices.
Researchers from the University of Colorado at Boulder and Columbia University have examined US mutual funds claiming to adhere to ESG principles, uncovering “significant disparities” in their operations. Their findings reveal a complex array of strategies that may leave investors questioning whether their values are truly reflected in these investments.
“ESG labels often mean 100 different things,” said Simona Abis, assistant professor of finance at UC Boulder’s Leeds School of Business, in an article on CU Boulder. “Since we don’t agree on what they all mean, misunderstandings can arise, even when funds are not trying to mislead investors.”
The study, conducted by Abis, Andrea Buffa (also from Leeds), and Meha Sadasivam (a Ph.D. candidate at Columbia), analysed actively managed mutual funds that primarily invest in US stocks. They identified funds with ESG-related strategies using a comprehensive dictionary of ESG terminology and manually reviewed each fund’s prospectus.
The researchers categorised the funds into three distinct types based on their findings. Exclusionary Funds focus on avoiding stocks that conflict with ethical or value-based criteria, such as those linked to poor labor practices, fossil fuels, tobacco, or firearms. Impact Funds prioritise ESG factors by selecting stocks not only for their financial returns but also for their societal and environmental contributions, such as sustainability efforts or positive community engagement. Lastly, Opportunistic Funds incorporate ESG considerations primarily to assess a company’s risks or return potential, even investing in companies with lower ESG ratings if they anticipate higher financial returns.
The study found that only 20% of ESG-labelled funds genuinely qualify as impact funds prioritising nonfinancial ESG goals, with the majority falling into exclusionary or opportunistic categories.
The lack of uniformity in ESG terminology could mislead investors who believe their investments align with ESG principles. “The challenge lies not just in how funds are labelled, but in the very meanings we attach to those labels,” Abis said. “Without clear definitions, a fund claiming to focus on ESG might be interpreted in countless ways, leading investors to believe they are supporting impact-oriented initiatives when they might not be.”
The popularity of ESG investing has surged in the past decade, dramatically increasing assets managed by these funds. In 2015, ESG funds represented 4% of active equity mutual funds and managed less than 2% of the capital in the industry. By 2022, ESG funds accounted for 22% of active equity funds and managed nearly 20% of invested capital.
However, the share of capital managed by impact funds—those prioritising societal and environmental benefits—has declined significantly. In 2015, impact funds managed 40% of assets in ESG-labeled funds, but this figure dropped to just 6% by 2022.
“This contrast highlights a key challenge: When we hear about a surge in ESG investment, we might mistakenly believe that it’s all about saving the planet. In reality, many funds are simply integrating ESG factors for risk management rather than pursuing a dedicated impact agenda,” Abis said.
