Finance-Accounting Seminar: Sustainability or Performance? Ratings and Fund Managers’ Incentives

We explore how mutual fund investors collectively value sustainability when the tradeoff with performance becomes salient. Following the introduction of Morningstar’s sustainability ratings (the “globe” ratings), mutual funds increased their holdings of sustainable stocks in an attempt to improve their globe ratings. This trading behavior created buying pressure, decreasing the returns of stocks with high sustainability ratings. Consequently, a tradeoff between sustainability and performance emerged and the performance of funds improving their globe ratings deteriorated. Since performance appears to be more important in attracting flows than sustainability, in the new equilibrium, the globe ratings do not affect investor flows and funds do not trade to improve their globe ratings.