Peer-driven greenwashing: insights from ESG mutual funds in the US PRI market
image: It further presents the population and AUM distributions of greenwashing funds in our sample period. As for 2021, 489 out of 2,984 mutual funds are PRI signatories in our sample, which manage $139.07bn of asset. However, we find that 178 out of 489 PRI signatories are actually greenwashing funds and $37.17bn out of $139.07bn are under managed by greenwashing funds, which share 36.4% ESG fund population and 26.72% ESG assets. The fraction and AUM of greenwashing funds have an average 3.53 and 10.32% growth rate respectively during our sample period. In addition, the greenwashing strategy for ESG mutual funds is highly persistent. ESG funds with below-median ESG score has probabilities of 92.07% to perform below-median for the next quarter investment.
Credit: Yutong Sun (Chinese Academy of Sciences, China) Shangrong Jiang (The University of Hong Kong, China Shouyang Wang (Chinese Academy of Sciences, China)
Background and Motivation
In recent years, Environmental, Social, and Governance (ESG) investment has experienced explosive growth, with ESG-labelled mutual funds attracting a rapidly increasing share of total assets under management. Yet, concerns persist regarding the authenticity of ESG claims, as a substantial portion of self-proclaimed ESG funds fail to deliver on their sustainability promises—an issue widely known as “greenwashing.” While previous research has highlighted the existence and drivers of greenwashing, little is known about whether this behaviour is contagious within the mutual fund industry and how it may affect genuine ESG funds. China Finance Review International (CFRI) brings you a new article titled ‘Contagious greenwashing investment’, which investigates the peer effects and contagion channels of greenwashing behaviour among ESG mutual funds in the US PRI market.
Methodology and Scope
The study constructs a comprehensive sample of actively managed US mutual funds, identifying ESG funds based on United Nations Principles for Responsible Investment (UN PRI) signatory status from 2009 to 2021. Greenwashing funds are defined as PRI signatories with below-median ESG scores. Using a two-stage least squares regression model, the authors disentangle the peer effects of greenwashing within fund families from family-level characteristics, employing cross-fund return standard deviation as an instrumental variable. The research further analyses the mechanisms and contagion channels through which greenwashing spreads, including fund flows, competitive tournament behaviour, shareholder proposal voting, and fund expenses, while also accounting for demand-side incentives from socially responsible investors.
Key Findings and Contributions
- Uncover the contagious nature of greenwashing within fund families: The study demonstrates that ESG mutual funds are more likely to adopt greenwashing strategies when their peer funds within the same family do so.
- Identify characteristics influencing greenwashing contagion: Larger, older funds and those with higher management fees are more resilient to greenwashing contagion, while team-managed funds are more susceptible.
- Show negative spillovers to genuine ESG funds: The presence and performance of greenwashing funds lead genuine ESG funds to lose capital inflows, increase portfolio risk, mimic questionable investment strategies, and even reduce support for shareholder ESG proposals.
- Reveal limits to investor detection: Socially responsible investors often struggle to distinguish genuine ESG funds from greenwashing funds, enabling the persistence and growth of greenwashing behaviour.
- Enrich the literature with new contagion channels and demand-side evidence: By mapping multiple transmission pathways and highlighting the role of both supply and demand, the study deepens our understanding of the systemic challenges facing ESG investing.
Why It Matters
These findings highlight a critical threat to the integrity of the ESG investment industry. As greenwashing strategies spread among mutual funds, the effectiveness of ESG investing in promoting sustainability is undermined, eroding trust among investors and stakeholders. Recognizing the contagion dynamics and the mechanisms that facilitate the proliferation of greenwashing is essential for designing better oversight, fostering transparency, and protecting the impact of genuine ESG investment.
Practical Applications
- For Researchers: This study provides new theoretical and empirical foundations for understanding how greenwashing spreads within the fund industry, offering novel mechanisms and channels for future research on ESG behaviour and peer effects.
- For Investors: The results underscore the importance of critical due diligence, as even well-intentioned investors may unknowingly support greenwashing funds. Enhanced ESG data transparency and improved screening criteria are crucial for more effective portfolio construction.
- For Policymakers and Regulators: The evidence supports the need for stricter disclosure requirements, more robust ESG scoring systems, and targeted regulatory action to limit the spread of greenwashing, ensure market integrity, and protect investor interests.
- For Fund Managers and the Asset Management Industry: Fund managers should recognise the risks and competitive pressures associated with greenwashing contagion. Developing internal controls, promoting authentic ESG strategies, and fostering a culture of transparency will strengthen long-term reputation and investor trust.
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