Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows

Question 1

What was the primary purpose of Morningstar introducing sustainability ratings in 2016?

Answer 1

To simplify and categorize ESG performance data for mutual fund investors.

Question 2

How did investors respond to the Morningstar sustainability ratings?

Answer 2

Funds with five globes saw substantial inflows, while funds with one globe experienced significant outflows.

Question 3

Why did the Morningstar ratings serve as a “quasi-exogenous shock”?
a) They unexpectedly affected a significant portion of the market without changing the fundamentals of the funds being rated.
b) They were anticipated by the market and only slightly influenced investor behavior.
c) They introduced new sustainability metrics, directly altering the funds’ performance.
d) They resulted in immediate regulatory changes to ESG reporting requirements.

Answer 3

A

Question 4

Which of the following best explains why investors allocated more funds to five-globe rated funds?
a) Investors believed five-globe funds had a higher financial return potential, supported by consistent evidence.
b) Five-globe funds were perceived as less risky and aligned with social and altruistic motives.
c) Morningstar ratings mandated institutional investors to prioritize five-globe funds.
d) Investors viewed one-globe funds as having the potential for higher long-term returns.

Answer 4

B

Question 5

What does the research reveal about the relationship between sustainability ratings and financial performance?
a) Highly rated sustainable funds consistently outperformed others financially.
b) There is no evidence that highly sustainable funds outperform others; evidence suggests the opposite.
c) Lower-rated funds showed better long-term performance due to reduced regulatory oversight.
d) Sustainability ratings were found to have no impact on financial performance.

Answer 5

B

Question 6

Why do institutional investors behave similarly to noninstitutional investors regarding sustainability ratings?

Answer 6

Institutional investors face social pressures and constraints that align their behavior with individual investors.

Question 7

What was the strongest driver of investor preference for highly rated sustainable funds?

Answer 7

Nonmonetary motives, such as social norms, altruism, and perceived lower risk.

Question 8

Why were flow effects strongest for one- and five-globe funds?

Answer 8

Investors focused primarily on the extreme categories, ignoring middle-tier ratings.

Question 9

How do investors perceive the riskiness of high-sustainability funds compared to low-sustainability funds?

Answer 9

High-sustainability funds are perceived as less risky, despite no evidence of financial outperformance.

Question 10

Why is it significant that investors prioritized simple globe categories over detailed sustainability scores or ranks?
a) It demonstrates investors’ preference for granular, detailed ESG data over simplified metrics.
b) It highlights the importance of clarity and simplicity in influencing investor behavior.
c) It shows that investors distrust Morningstar’s detailed sustainability analysis.
d) It indicates that sustainability scores and percentile ranks are irrelevant in investment decisions.

Answer 10

B

Question 11

What is the explanation for why both institutional and non-institutional investors invested more money in stocks with high ESG ratings despite no evidence of superior returns?

Answer 11

Institutional investors responded to regulatory and social pressures, while non-institutional investors were influenced by personal values and perceptions of sustainability.

Question 12

What were the financial implications for mutual funds categorized as low sustainability compared to high sustainability funds?


Answer 12

Low sustainability funds faced substantial outflows, while high sustainability funds experienced significant inflows.

Question 13

How did the investor response to the extreme globe categories (one or five globes) compare to the response to the intermediate globe categories (two, three, or four globes)?


Answer 13

Extreme globe categories received pronounced responses, highlighting investor focus on discrete, rather than continuous measures.

Question 14

Why was Morningstar’s sustainability rating considered a “quasi-exogenous shock”?


Answer 14

It did not change fund fundamentals but made ESG scores more visible.

Question 15

What did Hartzmark and Sussman (2019) find regarding the correlation between sustainability ratings and future returns?


Answer 15

No evidence supported a link between high ESG ratings and future outperformance.

Question 16

What role do institutional investors play in driving ESG-focused fund flows?


Answer 16

They face regulatory and social pressures to prioritize ESG-friendly investments.

Question 17

What percentage of the NYSE market cap was affected by Morningstar’s rating change?

A) 10%

B) 25%

C) 40%

D) 70%

Answer 17

C

Question 18

What psychological bias did investors exhibit in their reaction to sustainability ratings?

A) Confirmation bias

B) Overweighting extreme attributes (affect heuristic)
C) Loss aversion

D) Status quo bias

Answer 18

B

Question 19

What fundamental factor did Morningstar’s ESG rating system fail to change?


Answer 19

Underlying fund fundamentals

Question 20

What was the primary conclusion of Hartzmark and Sussman’s study?

Answer 20

Investors collectively value sustainability despite no financial advantage.

Question 21

What is the affect heuristic, as seen in investors’ response to ESG ratings?


Answer 21

A tendency to rely on emotions rather than analysis.

Question 22

Why do investors value sustainability?

Answer 22

Institutional constraints (face constraints that force them to behave like the other investors, or their preferences are similar to those of other investors), Rational performance expectations -> they might believe that sustainability is a positive predictor of future fund performance, Irrational expectations and nonpecuniary motives (altruism, warm glow and social motives)