The Effect of Environmental Preferences on Investor Responses to ESG Disclosure

Joanna Harris, Joint Program in Financial Economics PhD student

We study the effect of environmental preferences on portfolio allocation around the implementation of the European Sustainable Finance Disclosure Regulation (SFDR). In a model of asset allocation with heterogeneous environmental preferences, we show that the introduction of disclosure regulation leads to an increase in flows to ESG funds, and that investors with stronger environmental preferences are more responsive to the regulation. We also show that it can be optimal for some funds to overstate their true greenness and for others to understate it, which appears to be the case empirically. We then use unique security-level data on the holdings of investment fund shares across 24 European countries to study how environmental preferences affected the response to the SFDR. We find that ESG funds experienced higher flows after the regulation, and that the development of these funds was largest in countries with stronger environmental preferences. Institutional investors appear to be more responsive to the disclosure rules than household