Large financial institutions have been gathering far more brownie points for holding green stocks in their portfolios than they deserve, a new study by experts at Wharton and elsewhere has found. Green or ESG investing refers to investments in companies that adhere to ESG values (environmental, social, and governance) such as combating climate change or social inequities.

The study’s findings challenged popular perceptions about ESG investing, some of which peg that at $35 trillion. “That $35 trillion number overstates the amount of ESG investing; there is much less ESG investing than is popularly reported,” said Wharton finance professor Luke Taylor, who co-authored the paper, titled “Green Tilts,” with Wharton professor of finance and economics Robert F. Stambaugh and University of Chicago finance professor Lubos Pastor.

According to the paper, as of 2021, the biggest institutions collectively had ESG-related tilts in their portfolios of only 6% of the $31.3 trillion in assets they managed, which amounted to just about $2 trillion. The investment industry’s ESG-related tilt has been fairly steady at 6% throughout its sample period from 2012 to 2021.

The paper, which won a 2023 Outstanding Paper award from Wharton’s Jacobs Levy Equity Management Center, explained the large gap between actual ESG investments and those that are reported. A common approach to measuring ESG investing is to add up the assets under management of institutions that include ESG in their stated investment policies. But that approach does not consider the degree to which such institutions have modified their portfolios in ways related to assets’ ESG characteristics.

How Greenwashing Works

“For example, an institution may tilt its portfolio toward assets with favorable ESG characteristics, i.e., green assets, and away from unfavorable brown assets, but those tilts might be very modest, typifying a practice known as greenwashing,” the paper stated. A green asset could be the stock of a company that embraces environmentally friendly manufacturing policies, while a brown asset could be that of say, a polluting company or a tobacco products manufacturer.

“A fund — let’s say a mutual fund — might label itself an ESG fund, but engage in greenwashing, only tilting its portfolio a little bit toward green stocks,” Taylor said. “It’s just false advertising by the fund. Putting 100% of that mutual fund’s assets in the ESG bucket is surely too much.”

The conventional method of ascertaining ESG investments could work the other direction as well, when some institutions without a stated ESG policy “could nevertheless be making portfolio decisions related to ESG characteristics,” the paper noted.

“There is much less ESG investing than is popularly reported.” – Luke Taylor

Those institutions may make such investments because they want to hedge against climate risk or for financial reasons such as overweighting green stocks they see as underpriced, the paper explained. Taylor offered an example of how overweighting works: “If, say, Apple stock makes up 6% of the overall stock market, but some institution has a 7% weight on Apple, that would be a case of overweighting that stock.”

A Sharper Route to Identifying Green Tilts and Green Stocks

The study used a novel approach to arrive at the ESG investments of institutions: It estimated the ESG-related portions of institutions’ portfolio weights. It focused on equity portfolios of so-called 13F institutions, defined by the Securities and Exchange Commission (SEC) as those that hold at least $100 million in U.S. stocks. For each institution, it estimated how every stock’s ESG characteristics relate to the stock’s weight in the institution’s portfolio to determine its ESG-related tilt. It then aggregated those tilts across institutions to estimate the total ESG-related portfolio tilt in the investment industry.

The study identified the ESG-related tilts of financial institutions from 2012 through 2021, sourcing 13F filings from Thomson/Refinitiv and ESG ratings of some 2,000 stocks it covered from MSCI. The combined assets under management of the sample institutions grew from $9.7 trillion at 1,731 institutions in 2012 to $31.3 trillion at 3,086 institutions by 2021.

Increasingly Green Stocks: A Rising GMB Tilt

The study found that since 2012, the investment industry has become “increasingly green,” using a metric it called the “GMB tilt,” which is essentially a green tilt minus a brown tilt. The 13F institutions in its sample showed “a consistently positive and rising GMB tilt” between 2012 and 2021, it noted. In contrast, the aggregate portfolio of non-13F investors had become browner, or they showed “a negative and decreasing GMB tilt.”

Delving deeper, the study found that the relatively larger 13F institutions achieved their rising GMB tilt by “increasingly overweighting green stocks and underweighting brown stocks.” Their divestment from brown stocks was mostly by reducing their positions in them rather than eliminating them, it pointed out.

For every investor who tilts green, there must be another investor tilting brown, because investors collectively hold the entire market, Taylor pointed out. “Our finding that GMB tilts are increasing means that investors in our sample hold portfolios that look increasingly green, which then implies that investors outside our sample must be holding portfolios that look increasingly brown,” he added.

Getting Granular With E, S, and G

The study refined its measurement of ESG-related tilts by taking into account the individual E, S, and G characteristics from MSCI ratings of company stocks. With that approach, it isolated tilts toward stocks’ E, S, and G characteristics after controlling for non-ESG characteristics, the paper stated, and went on to explain how that works: “For example, an institution may hold Tesla’s stock because it views Tesla as environmentally friendly or because it likes holding large-cap growth stocks. Our approach separates the two motives. Second, our approach allows the three dimensions of ESG to enter separately, recognizing, for example, that investors may assess Tesla’s environmental virtues separately from Tesla’s treatment of its employees.” Significantly, the paper pointed out that using only a composite ESG score misses over 40% of the tilts associated with E, S, and G characteristics.

“It’s just false advertising by a fund. Putting 100% of that mutual fund’s assets in the ESG bucket is surely too much.” – Luke Taylor

Large Institutions Lead the Path Toward Green Stocks

The largest third of 13F institutions do the heavy lifting in raising the overall industry’s tilts toward green stocks. The smallest two-thirds of 13F institutions have a brown tilt. Institutions that are signatories to the United Nations’ Principles for Responsible Investment (UNPRI) tilt greener, while banks tilt browner, it added. Other institutions (non-13F investors) and households tilt increasingly toward brown stocks, the paper noted.

Taylor explained the increasing green tilts among the 13F institutions. “The largest institutions, like Blackrock, Vanguard, Fidelity, and State Street, are simply catering to their clients’ demands,” he said. “Clients of those firms increasingly want to hold a portfolio that tilts green. They may do that for a variety of reasons: a desire to behave ethically; a desire to have a positive impact on the world; a view that green stocks are underpriced and therefore expected to perform well; or a desire to hedge certain risks, e.g., climate-related risks. Investors who care less about those things mainly don’t use the large institutions, and they’re content with holding a portfolio that tilts brown.”  

Takeaways for Investors, Companies, and Regulators Handling Green Stocks

Broadly, the top takeaway from the study is that it brings clarity to the debate on ESG issues, with opinion divided on whether there is too much or too little of ESG investing. “It’s hard to say that there’s too much or too little ESG investing without first knowing how much ESG investing there is,” Taylor pointed out.

The clarity the study brings to ESG investing also helps investors. For example, an investor in, say, a mutual fund would probably like to know if it is a green fund or a brown fund, Taylor noted. “Let’s say you’re an investor who loves ESG, loves green companies, and so you want a portfolio that’s tilted green. You may do it for ethical reasons. You may want to do it for impact reasons. You may want to do it to make high returns if you think green stocks are good investments financially. But you definitely want to know how tilted you are in your investment. A little bit or a lot?”

ESG investors should also beware of “greenwashing,” where companies or institutions overstate the green features of their businesses or portfolios, Taylor said. “For example, a fund may advertise itself as an ESG fund without having large ESG tilts in its portfolio,” he said. “It would help if funds reported their true ESG-related tilts more carefully.” He noted that Morningstar’s Sustainability Ratings are “a move in that direction,” adding that more could be done on that front. “It would be nice to see funds report their ESG-related tilt; the E, S, and G components; and the degree to which those tilts are in a green versus brown direction.”

Companies, too, would like to be aware if investors are tilting green or brown, and if so, to what degree, he noted. If not now but in the future, “regulators might want to have better visibility into how green or brown certain investment vehicles are,” he said. “And [with our study], we provide a way for them to answer that question.”