The force is with SRI/ESG funds
Corporations have found value in catering to the needs and tastes of Generations X, Y and Z, identifying and understanding their values and embracing socially responsible (SRI) and environmental, social and governance (ESG) criteria goals. Tech giants such as Google claims they are “Raising the bar in making smart use of the Earth’s resources, expecting the highest ethical standards throughout our supply chain and creating products with people and the planet in mind”. These sentiments certainly mesh with large segments of their customer base, which is not shy about demanding that they strive for these standards.
Efforts such as these are being rewarded by mutual fund managers. Over the past six years, ESG funds have experienced far more success attracting fresh money than their non-ESG counterparts (see chart below).
Only the good count more
The SRI/ESG designation is clearly good for the asset gathering of the funds that adopt it. But what, if anything, does that mean for the stocks that find their way into the portfolios of SRI/ESG Equity Funds?
Chen, Hong and Stein have established that stocks owned by many funds perform better than those held by fewer. Given the momentum enjoyed by SRI/ESG Funds, it is worth asking if there is an additional premium for stocks that comes with ownership by these funds. What if, as in pre-Norman England when the word of a thane counted for that of six churls, being owned by an ESG fund mattered more than being owned by another fund?
In this Quant’s Corner, we use a novel dataset from EPFR -- based on self-reported stock-level holdings of funds -- to establish the findings of Chen, Hong, and Stein and then demonstrate that ESG funds do, indeed, count for more.
Connecting the dots
EPFR has a monthly database of self-reported stock-level equity fund holdings. Constrained by the agreements under which they collect the data, they are not able to pass on fund-level holdings to clients. However, so long as they aggregate this information, thereby preserving the anonymity of the fund holdings, they can produce factors that can be sold to clients.
One of these factors is a simple count of the number of funds holding a given security: the fund-count factor of Chen, Hong and Stein. EPFR also classifies whether a fund is socially responsible or not, based on the fund’s fact sheet. It is therefore a simple matter to count the number of ESG funds that hold a security.
We use these two factors, together with returns from Bloomberg, to validate the findings of Chen, Hong and Stein and to gauge the impact of SRI/ESG funds. To do so, we get the number of funds holding each security at the end of the previous month, sort the stocks in ascending order in terms of this measure, and assign them to one of five quintile portfolios. These portfolios are rebalanced monthly using equal weights.
We run these simulations on the stocks in the S&P500, Russell 1000, MSCI EAFE and MSCI EM indexes, using the all funds count, then repeat them using counts for ESG funds and non-ESG funds. The table below shows the annualized average monthly returns to the top quintile (highest fund ownership) in excess of that of the bottom quintile (lowest fund ownership). The column “Cross-univ average” is simply the equal-weighted average of the quintile spreads across the four universes.
As you can tell from the table, the fund count factor of Chen, Hong and Stein (labelled “All Funds”) does indeed work. Not surprisingly, in view of the money being thrown at them, ESG fund ownership (“ESG Funds”) is a better factor. In the US, non-ESG fund ownership (“Non-ESG funds”) matters, but not overseas.
Finding in favor of the thanes
Having established that SRI/ESG fund ownership of a stock has a greater impact, we need measure just how great that impact on stock values is.
To do so, we start by collecting (a) monthly returns for each universe of stocks and (b) ESG and total fund ownership from two months prior. We then proceed to run a regression of fund return against fund ownership (“Count of funds”) and ESG fund ownership (“Count of ESG funds”). Returns are mean adjusted for each month, on each universe, to avoid bias. Because these fund-count factors worki less well on the MSCI EM universe of stocks than on other universes, we repeat this regression excluding MSCI EM stocks.
The panel below shows estimates and t-statistics for the fund count and ESG fund count predictors.
As you can see from the table, the coefficients and t-statistics on fund count and ESG fund count are similar. The row labelled “Multiple” is one (because ESG funds are counted in both the ESG and All Fund categories) plus the ratio between the coefficients on ESG fund count and fund count. It is trying to measure how many regular funds one ESG fund is worth. In this case, the word of a thane amounts to that of two churls.
The number of funds owning a security does drive security prices. One gets a better metric by double counting ESG fund ownership.
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