The complex materiality of ESG ratings: Evidence from actively managed ESG funds

We introduce Active ESG Share as a novel metric of the extent of a fund manager’s use of ESG information. Active ESG Share compares the full distribution of a portfolio’s stock-level ESG ratings to that of its benchmark, capturing how actively a manager uses ESG information, rather than whether the manager tends to favor stocks with high or low ESG ratings. We find a positive relation between Active ESG Share and the future performance of actively managed mutual funds, but only among ESG funds, which we attribute to the importance of specialization. The results are strongest for ESG funds that tend to hold stocks with a high level of ESG ratings disagreement or uncertainty, consistent with such disagreement and uncertainty creating opportunity for active managers. Our results suggest that ESG information is financially material, but complex, and thus cannot be successfully capitalized on using simple directional strategies.