Behavioral Biases in ESG Investing

Table of Contents

1 Introduction

2 Theoretical background

2.1 ESG investing as a special form of investment

2.1.1 Fundamentals of investing, mutual Funds and fund managers in general

2.1.2 Conceptual delimitation and special features of ESG investing

2.2 Behavioral biases and their influence on investment decisions

2.2.1 Traditional finance vs Behavioral finance

2.2.2 Behavioral biases

3 Literature review

3.1 ESG investing

3.1.1 Sustainable investing and financial performance

3.1.2 Behavior of ESG investors

3.2 Behavioral biases and their potential role in ESG investing

3.2.1 Home bias and Europe bias

3.2.2 Industry bias

4 Hypothesis development

4.1 Behavioral biases of ESG mutual funds

4.2 Performance of ESG mutual funds

5 Data and methodology

5.1 Data and descriptive statistics

5.1.1 Data

5.1.2 Descriptive statisics

5.2 Methodology of measuring behavioral biases

5.2.1 Home bias

5.2.2 Europe bias

5.2.3 Industry bias

5.3 Performance measures

5.3.1 Capital-asset-pricing model

5.3.2 Carhart four-factor model

5.3.3 Characteristic based performance measure

5.3.4 Regression model

6 Results

6.1 Main results of behavioral biases in ESG mutual funds

6.1.1 Evidence of home Bias

6.1.2 Evidence of Europe Bias

6.1.3 Evidence of industry Bias

6.2 Main results of the performance analysis of ESG mutual funds

6.2.1 Performance measures

6.2.2 Impact of behavioral biases on ESG mutual fund performance

6.3 Robustness

6.3.1 Alternative measurement approaches

6.3.2 Sub-period performance

6.3.3 Performance before and after expenses

6.3.4 Robustness home bias

6.3.5 Robustness Europe bias

6.3.6 Robustness industry bias

7 Limitations

8 Conclusion

Research Objective and Topics

This master's thesis investigates whether the ambiguous performance relationship of ESG mutual funds is rooted in behavioral biases. The research explores if these funds, domiciled in Europe, exhibit specific home, European, and industry biases, and analyzes the impact of these deviations on fund performance and diversification, using asset pricing models (CAPM and Carhart four-factor) over the period from 2017 to 2021.

• ESG investing and its definition
• Behavioral finance theories vs. traditional finance
• Identification of home, Europe, and industry biases in ESG funds
• Performance analysis using CAPM and Carhart four-factor models
• Impact of behavioral biases on ESG portfolio diversification

Excerpt from the Book

Summary of Chapters

1 Introduction: Provides an overview of the growth of sustainable investing and defines the research scope regarding behavioral biases in ESG mutual funds.

2 Theoretical background: Explains the foundations of ESG investing, mutual fund mechanics, and the shift from traditional finance to behavioral finance.

3 Literature review: Reviews existing empirical studies on the performance of ESG investments and the behavioral patterns of both individual and institutional investors.

4 Hypothesis development: Derives nine hypotheses regarding the susceptibility of ESG funds to home, Europe, and industry biases and their resulting impact on fund performance.

5 Data and methodology: Describes the dataset of 340 ESG mutual funds, matching procedures with conventional peers, and the quantitative models used to identify biases and measure performance.

6 Results: Presents the empirical findings confirming that ESG mutual funds exhibit specific behavioral biases and analyzes the resulting effects on their risk-adjusted returns.

7 Limitations: Discusses factors affecting the results, such as the quality of ESG data, lack of standardized reporting, and the impact of the regulatory environment.

8 Conclusion: Synthesizes the main findings, confirming that while ESG funds show specific biases, their impact on performance varies and provides suggestions for future research.

Keywords

ESG investing, Behavioral Finance, Home Bias, Europe Bias, Industry Bias, Mutual Funds, Portfolio Performance, CAPM, Carhart four-factor model, Rationality, Market Efficiency, Sustainable Finance, Diversification, Idiosyncratic Risk, Asset Allocation.

Frequently Asked Questions

What is the core focus of this research?

The research examines whether ESG-focused mutual funds are subject to specific behavioral biases—namely home bias, Europe bias, and industry bias—and how these biases affect their financial performance.

What are the primary thematic areas covered?

The work covers ESG fund characteristics, behavioral finance theories, performance measurement through factor models, and the comparison between ESG and conventional "twin" funds.

What is the primary research question?

The thesis seeks to determine if the mixed empirical findings regarding ESG fund performance can be explained by their susceptibility to systematic behavioral biases leading to under-diversification.

Which scientific methods are employed?

The study employs a quantitative approach using the Capital Asset Pricing Model (CAPM) and the Carhart four-factor model to calculate abnormal returns (alpha), alongside multivariate regression analyses to test the impact of identified biases.

What is discussed in the main body of the work?

The main body systematically reviews literature, defines the hypotheses, outlines the methodology for data collection (using Refinitiv Eikon), and details the results of bias and performance analyses for the period 2017–2021.

Which keywords define this study?

Key terms include ESG investing, Behavioral Finance, Home Bias, Industry Bias, Portfolio Performance, and Mutual Funds.

Does the study find that ESG funds underperform?

Results are mixed depending on the model; however, the study finds that ESG funds significantly outperform their matched conventional counterparts when directly compared, though this performance is not always statistically significant when using standard benchmark models.

How does the Europe bias affect ESG funds?

The findings show that ESG funds often over-allocate to European stocks. While this increases idiosyncratic risk, it does not necessarily negatively impact performance, suggesting potential informational advantages for managers in this region.