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1、OXFORDDOWn-Oaded Hom h-tps7academ6oupcomro=artole281/45/7103324 by UrWerS=y Of-merna-na- BUS5ess and EConom6S USer On 20 FebrUary 2024ReviewofFinance,2024,45-74https:/doi.Org/10.1093rofrfad015AdvanceAccessPublicationDate:4April20231.owCarbonMutualFunds*MarcoCeccarelli,StefanoRamelli,andAlexanderF.Wa
2、gner1MaastrichtUniversity,TheNetherlands,2UniversityofSt.GallenandSwissFinanceInstitute,Switzerlandand3UniversityofZurich,CEPR1ECGI,andSwissFinanceInstitute,SwitzerlandAbstractClimatechangeposesnewchallengesforportfoliomanagement.Inournot-yet-lowcarbonworld,investorsfaceatrade-offbetweenminimizingth
3、eirexposuretoclimaterisksandmaximizingthebenefitsofportfoliodiversification.Thisarticleinvestigateshowinvestorsandfinancialintermediariesnavigatethistrade-off.AfterthereleaseofMorningstarsnovelcarbonriskmetricsinApril2018,mutualfundslabeledaslowcarbonexperiencedasignificantincreaseininvestordemand,e
4、speciallythosewithhighrisk-adjustedreturns.Fundmanagersactivelyreducedtheirexposuretofirmswithhighcarbonriskscores,especiallystockswithreturnsthatcorrelatedmorewiththefunds*portfoliosandwerethuslessusefulfordiversifica-tion.Thesefindingsshedlightonwhetherandhowclimate-relatedinformationcanre-orientc
5、apitalflowsinalowcarbondirection.Keywords:Behavioralfinance,Portfoliomanagement,Climatechange,Investorpreferences,Mutualfunds,SustainablefinanceJELclassification:D03,G02,G12,G23ReceivedJune3,2021;acceptedMarch5,2023byEditorMarcinKacperczyk.,WethankseminarparticipantsatMaastrichtUniversrty,EuropeanCo
6、mmissionsJointResearchCenter,QueenMaryUniversity,UniversityofZurich,UniversityofLiechtenstein,UniversityofSt.Gallen,CorporateFinanceWebinar,UniversityofMannheim,the2019CEPREuropeanSummerSymposiuminFinancialMarkets(eveningsession),the2019GRASFInference,the2019HelsinkiFinanceSummit,the2019PRIacademicc
7、onference,the2020UZHSustainableFinanceconference,the2020WesternFinanceAssociationconference,andtheESSEC-AmundiGreenFinancewebinarforusefulcomments.WearealsogratefultoMarcinKacperczyk(editor),twoanonymousco-editors.ananonymousreferee.MarieBriere,MiguelFerreira,StefanoGiglio,SamuelHartzmark,AugustinLa
8、ndier,StevenOngena,MelissaPrado.BertScholtens,PaulSmeets,LucianTaylor,MichaelViehs1andStefanZeisbergerforusefulsuggestions.WethankHortenseBioyandSaraSilanoatMorningstarforhelpfulclarifications.A.F.W.thankstheUniversityofZurichResearchPriorityProgramFinancialmarketregulationforfinancialsupport.Theaut
9、horsdeclarethattheyhavenorelevantormaterialfinancialintereststhatrelatetotheresearchdescribedinthisarticle.VcTheAuthor(三)2023.PublishedbyOxfordUniversityPressonbehalfoftheEuropeanFinanceAssociation.ThisisanOpenAessarticledistributedunderthetermsoftheCreativeCommonsAttributionLicense(https：/CreatiVe8
10、m-mons.org沛CenSeSy4.0),whichpermitsunrestrictedreuse,distribution,andreproductioninanymedium,providedtheorigin-alworkisproperlycited.1.IntroductionHowshouldinvestorsbehaveinthefaceofclimate-relatedrisksandtheenergytransitiontoalowcarbonworld?Toanswerthisquestion,itisimportanttorecognizethataccount-i
11、ngforclimaterisksininvestmentdecisionsbringsinvestorsbothbenefitsandcosts.Ontheonehand,shunningcarbon-intensive,“brown“assetscanreduceaninvestorsexposuretoclimaterisks.Theseriskshaveyettofullymaterialize,bothintermsofphysicalconsequencesandsocietalreactions,andmanyobserversbelievethattheyarecurrentl
12、yunderestimatedinassetprices(StroebelandWurgler,2021).Ontheotherhand,inournot-yet-Iowcarboneconomy,excluding“brown“assetsandinvestingonlyinthoseconsidered“green”requireinvestorstoforegoopportunitiestodiversify.Thistrade-offisparticularlysalientinassetmanagement,whereportfoliodiversification,notonlyt
13、hefeaturesofindi-vidualsecurities,playsacrucialroleinreducingoverallinvestmentrisk(Markowitz.1952).Inthisarticle,westudyhowinvestorsandassetmanagersnavigatethistrade-off.Wefocusonthemutualfundindustry,whichrepresentsanimportantshareofglobalfinancialmarkets,andexploitaquasi-naturalexperimentinvolving
14、asuddenincreaseinboththeavailabilityandsalienceofinformationoncarbonrisk(climatetransitionrisk),thatis,theclassofriskderivingfromthetransitiontoalowercarboneconomy.AswedescribeinmoredetailinSection2,onApril30,2018,Momingstar,themostimportantdataproviderinthemutualfundindustry,releasedanewPortfolioCa
15、rbonRiskScorederivedfromHnn-IeveldataprovidedbySustainalytics,whichMomingstarhascontrolledsince2017.ThenoveltyofMorningstarsPortfolioCarbonRiskScoreishighlightedbythefactthatitcor-relatesonlymildlywithotherportfoliometrics,basedonpreviouslyavailableenvironmen-talscoresfromSustainalytics,Refinitiv,an
16、dMSCIKLD.Basedonitsnewcarbonriskscore,combinedwithrelativelystandardinformationonfirmsfossilfuelinvolvement(FFI),Momingstaralsoissuedaneco-labelIbrmutualfundsthelowcarbondesignation(LCD).WeusealargesampleofactiveEuropeanandUSmutualfundstostudyinvestors,andfundmanagersreactionstotheseinformationshock
17、sproducedbythepublicationofMorningstar,sPortfolioCarbonRiskScoreanditsassociatedLCDeco-label.Wedevelop(heconceptualframeworkguidingourempiricalanalysesinSection3.Wefirstconfirmthat,inlinewithextantliterature(e.g.,Engleetal.2020;BoltonandKacperczyk,202la),individuallowcarbonsecuritiesarelessriskythan
18、otherfirms,bothintermsofexposuretonegativeclimatechangenewsandrealizedreturnvolatility.Wethenshiftourfocustotheportfoliolevel.Onemaynaivelythinkthattheriskpropertiesoflowcarbonfundsshouldmirrorthoseoftheirlowcarbonholdings.Such,wefind,isnotthecase.Theinvestmentriskofaportfoliodependsnotonlyonthevari
19、anceofitsindivid-ualholdings,returns,butalsoonthecovarianceofthesereturns(Markowitz,1952).Empirically,whilelowcarbonfundshavelowerexposuretoclimaterisks,theirvolatilityisnotlowerthanthatofmoreconventionalfunds.Infact.Wefindthatthemutualfundswiththelowestcarbonriskscoreshavehighervolatilitythanthosew
20、ithmedianscores.Thesourceofthisresultisthehighdegreeofindustryconcentration(Kacperczyk,Sialm,andZheng,2005)oflowcarbonfunds.ThesefundsoverweightIT.retail,andhealthcarefirms,DOWnoaded from h=psacadem6bupcomro-art6(28l457103324 by Un-Versw o-serna Hona- BUSess and EConom6s USer 0 20 FebnJary 20241In20
21、20,open-endmutualfundshadsomeUSD63trillioninassetsundermanagementworldwide,representingaround26%ofequityanddebtsecuritiesoutstanding(InvestmentCompanyInstitute,2021).whiletheyunderweightenergy,materials,andutilityfirms.Beyondtheindustryconcentra-tion,thefactthatlowcarbonfundsholdfewerstocksdoesnotsi
22、gni11cantlyfurtherexplaintheirsurprisinglyhighvolatility.Overall,lowcarbonfundsholdassetsthat,althoughindi-viduallylessrisky,haveahighdegreeofcovariance,limitingrisk-sharing.InSection4,westudythereactionsofmutualfundinvestorstotheApril2018informa-tionshock.FundsreceivingtheLowCarbonDesignationenjoye
23、dasubstantialincreaseintheirmonthlyflowsrelativetootherfunds.TheeconomicimpactoftheLCDlabelcorre-spendstoanaverageincreaseinflowsofapproximately36basispointseachmonththroughtheendof2018;thisincreaseisequaltoabouttwo-thirdsoftheeffectonflowscausedbyaone-standard-deviationstrongermonthlyfinancialperfo
24、rmance.Beforethenewdatabecameavailable,investorslikelyusedMorningstarssustainabilityGlobesasanimperfectproxyforexposuretocarbonrisk.Intuitively,ifafundwithfewGlobesreceivedtheLCD,itwouldcomeasalargersurprisetoinvestors.Consistentwiththislogic,wefindlargereffectsonflowsinsuchsituations.Inaddition,LCD
25、-labeledfundswithstrongrisk-adjustedperformanceexperiencedamorepronouncedflowpremium.Moreover,afterthepublicationoftheLCDlistbutnotbeforequalifyingforthelowcarboneco-labelresultedinparticularlylargeextraflowsinmonthsofgreaterattentiontoclimatechange,asmeasuredbyGglesearchintensity.Alltheseresultsare
26、consistentwithinvestorstakingboththebenefitsandthecostsintoaccountwheninvestinginlowcar-bonfunds.InSection5,weemployadatasetofmonthlyportfolioholdingstostudythereactionsoffundmanagerstothereleaseofMomingstar,sportfolioandfirm-levelcarbonriskinfor-mation.Weshowthat,afterApril2018.fundmanagersactively
27、rebalancedtheirportfoliostoreducetheircarbonrisk.Onaverage,relativetotheperiodbeforethepublicationofMorningstarscarbonriskmetrics,mutualfundsreducedtheirpositionintheaveragehighcarbonriskfirmbyabout0.17basispointsoftheirassetsundermanagement(AUM)permonth.Thiseffectiseconomicallymeaningful,considerin
28、gthatthemedianmonthlypos-itionchangeiszeroforthewholesampleand2.8basispointsfornon-zeropositionchanges.Managersreactedtocarbonrisknotonlywithaone-shotrebalancingoftheirport-folios,butalsobyintegratingthenewinformationintotheirflow-driveninvestmentdeci-sionsaftertheinitialshock.Inparticular,weobserve
29、thatfundsexperiencinglargenegativenetflowssoldhighcarbonriskassetsmoreaggressivelythandidotherfunds,whilefundsexperiencinghighinflowsincreasedtheirstakesinlowcarbonriskassets.Furthercross-sectionalevidenceindicatesthat,asweexpected,fundswithhigherexanteindustryconcentrationreactedmorestronglytothere
30、leaseofthenewcarbonriskin-formation.Forthesefunds,shiftingtolowercarbonriskassetsislesslikelytodecrease(andmayevenincrease)theirdiversification.Theyarealsolikelytoserveclientswhoarelessinterestedinbroaddiversificationinthefirstplace.Importantly,wefindthatwhenmanagersreducedtheirpositionsinstockswith
31、ascoreofmediumorhighcarbonrisk,theydidsomoreaggressivelyforthosewithahigherreturncovariancewiththeremainderoftheportfolio,consistentwithanattempttopreservediversification.DOWn-Oaded Hom h-tps7academ6oupcomro=artole281/45/7103324 by UrWerS=y Of-merna-na- BUS5ess and EConom6S USer On 20 FebrUary 2024T
32、hisarticlecontributes,first,byprovidinginsightsintothebenefitsandcostsofgreeninvestmentproducts.Existingresearchsuggeststhatfirmswithbetterenviron-mentalperformancehavelowerexposuretoclimate-relatedrisks,andarepricedac-cordingly(e.g.,Engleetal.2020;BoltonandKacperczyk,202la.2021b;HuynhandXia,2021:Il
33、han,Sautner,andVilkov,2021;Ramellietal.2021b;Hsu,Li,andTsou,2022).However,howtheskpropertiesofindividualgreensecuritiestranslatetotheportfoliolevelisstilllargelyunexploredand,asweshow,notobvious.Thetrade-offattheportfoliolevel2thatwehighlightinthiscontextisconsistentwiththetheoreticallit-eratureongr
34、eeninvesting.Second,wecomplementtheliteratureonwhetherandwhyinvestorsprefersociallyresponsibleinvestmentproducts(e.g.,Bollen.2007;Renneboog,terHorst,andZhang.2011;RiedlandSmeets,2017：Bassenetal.2019;HanzmarkandSussman.2019：Barber,Morse,andYasuda,2021;Bauer,Ruof,andSmeets,2021;Geczy,Stambaugh,andLevi
35、n,2021;AndersonandRobinson,2022).Theresponsestothequasi-naturalexperimentthatWeanalyzehighlightboththecostsandbenefitsofsociallyresponsibleinvestmentproducts,crucialforunderstandingthecomplexityofinvestorbehavioronsustainabilityissues.Intennsofcosts,lowcarboninvestingasksinvestorstopayapriceintermso
36、flowersectoraldiversification,atleastintheshortterm.Genericsustainableratings/products,incontrast,areusuallybasedon“bestinclass”approachespreciselytoallowinvestorstonotgiveupanysectoraldiversification.Intermsofbenefits,theeventweanalyzeallowsafocusoninvestorsspecificclimate-relatedpreferences.Asdocu
37、mentedbyHanzmarkandSussman(2019),theinvestorsWestudyhadalreadyselfselectedintofundsbasedontheirgenericsustainabilitypreferences.Ourresultsindicatethatboththecostandbenefitsidesoflowcarboninvestingshapeinvestorresponses.Third,wecomplementtheliteratureonprofessionalmoneymanagerbehavior.Severalstudiesc
38、onsiderfundmanagerbehaviorasafunctionoftraditionalfinancialperformancemetrics,butinrecentyears,ESGfactors,andclimate-relatedconsiderationsinparticular,havegainedimportanceintheindustry.Forinstance,Krueger,Sautner,andStarks(2020)andIlhanetal.(2023)providesurveyevidenceontheimportanceofclimaterisksfor
39、insti-tutionalinvestors.BoltonandKacperczyk(202la)showthatinstitutionalinvestorsapplycarbon-relatedscreensandChoi,Gao,andJiang(2023)documentadecreaseininstitution-alinvestorsexposuretocarbon-intensivedomesticfirmsafter2015.Fundmanagerschangetheirholdingsaftershiftsinclimateriskperceptionduetonatural
40、disasters(Alok,Kumar,andWermers,2020)orextremeheatevents(Alekseevetal.2021).Gantchev.Giannetti,andLi(2022)studyfundmanagers*tradingbehaviorwithrespecttofirms,sus-tainability,focusingonthepricepressureimplicationsonindividualstocks.Ourarticlecontributestothisliteraturebystudyinghowfundmanagersactivel
41、ychangedtheirport-folioholdingsfollowingincreasedtransparencyonclimaterisksinthemutualfundindustry.DOWnoaded from h=psacadem6oupcomrofart6-e28H457103324 by unn risk scores by the total investment (debt and equity) that a fund holds in a given company at the end of the quarter. A Portfolio Carbon Risk
