How Pessimism Drives Sustainable Investing

Think of the last time you bought something very expensive to feel better after a disappointment, or decided to pay for dinner at a fancy restaurant after a personal achievement.

Emotions have a big influence on our buying decisions. More often than we realize, we make these decisions based on emotions rather than rational calculations or data. Not only in our daily lives, but also in our financial decisions, emotions play an important role.

Investors are more pessimistic about the company’s future earnings when their morale is low, and this is associated with decline in stock prices.

Given the growing popularity of financial assets with environmental, social and corporate governance (ESG) criteria, i.e. companies with corporate policies that promote social and environmental responsibility, we have wanted to know what role emotions play in preferences for sustainable investments.

Why do we choose sustainable investments?

There are several reasons why we are attracted to sustainable assets. Some of us want to brag about being sustainable. For example, we like to talk about how our investments help improve the environment or reduce poverty in developing countries.

Another reason could be found in the way we were educated at home: the desire to invest in sustainable assets can be influenced by parental investments in these assets or by growing up in a family that values ​​sustainability.

The effect warm glow, i.e. the pleasant feeling felt after making a donation, also explains why investors choose sustainable assets. In this sense, the experience of investors Positive emotions when choosing sustainable assets, regardless of the real impact of their investments on the common good.

But can the mood of investors influence their preferences for sustainable assets? There are several reasons that could explain why emotions influence where we invest our savings.

Woman looking at investments on computer and phone screens.
Durable assets are benefiting from lower investor sentiment.
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The role of emotions

There are two competing theories that examine the role of mood in sustainable investing.

The first theory is based on the idea that sustainable assets are safer, that is, they present less risk. In this sense, financial assets classified as sustainable tend to perform better than non-sustainable assets in times of crisis, since investors consider them more reliable and with less structural, legal and reputational risks.

This theory is complemented by the idea that investors are more risk averse when their mood is down. In other words, when you are more sad, depressed or angry, you tend to be more cautious in your investment decisions and choose lower risk investments.

A second theory, competing with the previous one, is based on the idea that a positive state of mind promotes behavior in favor of the common good and promotes altruism. In other words, moody investors care more about themselves and less about others and, therefore, have a lower preference for durable assets.

Enthusiastic investors, on the other hand, might be more altruistic and favor sustainable investing, as it would benefit others.

In our article, we compare these theories and find that the effect of risk aversion dominates the possible positive effect of altruism in sustainable investing.

Specifically, we found that a deterioration in investor sentiment is associated with higher investments in durable assets. This result may be due to the fact that the rise in risk aversion is forcing investors to favor durable assets perceived as safer.

Sustainable funds and mood

To identify sustainable investment funds, we use the Morningstar sustainability rating, the world’s largest investment fund rating agency. The objective of this classification is to help investors understand and assess the environmental, social and corporate governance risks of their investments. A higher sustainability rating represents a lower risk.

To capture the change in household mood in a given month, we use a measure called startup and recovery (WHERE in its acronym in English). This measures the change in the monthly percentage of people who show symptoms of seasonal depression.

The higher the OR, the greater the increase in cases of seasonal depression and, therefore, the more the mood of households deteriorates. In countries of the northern hemisphere, OR has a maximum in autumn (September), a minimum in spring (March) and is moderate in summer and winter. Countries in the southern hemisphere have the opposite pattern.

In our article, we study the relationship between RO levels and investment in sustainable mutual funds in 25 countries between 2018 and 2021.

In general, we found that investment funds with a high sustainability rating attract more capital, suggesting that investors value sustainable investments positively.

More importantly, we found that as the percentage of individuals with seasonal depression increases, the equity of high sustainability funds increases relative to less sustainable alternatives (an additional percentage of 0.07% per month or 0.84 % per year). ).

For a representative mutual fund worth $100 million, this additional capital is equivalent to approximately $840,000 per year.

This negative relationship is consistent with the interpretation of investors’ risk aversion, supporting the conclusion that weaker household sentiment favors durable assets, which are perceived as safer.

These results should be taken with caution. Given the characteristics of our data, we cannot test whether investor sentiment improves after investing in sustainable mutual funds. This would not only confirm that sustainable investments are a safe option, but also that investing in them would improve the mood of individuals.

Is sadness good for the environment?

Our work investigates a lead that could explain why investors choose sustainable assets.

The results suggest that, relative to investments in sustainable equity funds, risk aversion caused by investor pessimism may be a more likely cause of the increase in sustainable investments than the possible happiness associated with sustainability. altruism and the common good.

This is not to say that sadness is good for the environment or society, but it does confirm that investors view sustainable assets as a safer option.

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