Saving Energy: A Decline in Active Management of ESG-Oriented Mutual Funds

This paper examines the evolution of active management among conventional and ESG-oriented U.S. equity mutual funds. While active stock-picking is essential for diligent responsible investing, an analysis of 4,183 actively managed mutual funds from 2011 to 2022 reveals a general decrease in active management across all funds, with ESG-oriented funds exhibiting a stronger decline after 2018. Furthermore, the study finds a decrease in active management relative to ESG-screened market indexes across all mutual funds, irrespective of their ESG orientation. Using a novel decomposition of active management into fund-to-market and market-to-fund changes, the analysis shows no evidence that ESG funds have begun to align more closely with market portfolios. However, the paper finds that major market-cap-weighted S&P 500 index began to more closely mirror the portfolio compositions of ESG-oriented funds after December 2018 compared to the portfolios of non-ESG funds. Moreover, increased investor inflows into ESG funds contributed to a reduction in their active deviation from market portfolios, suggesting that ESG funds shifted toward more benchmark-aligned, passive strategies in response to heightened investor attention. These findings suggest that the growing demand for sustainable investing, which was once mainly a focus of ESG-oriented funds, has gradually spread across the broader market, contributing both to greater alignment with ESG principles and to the reduced reliance on active management strategies within ESG-oriented funds.