Drifting from the Sustainable Development Goal: Style Drift in ESG Funds

In this paper, we investigate the impact of fund style drift away from sustainability on future fund flows and performance within the Chinese market. Utilizing data from four mainstream ESG rating systems, we develop a novel measure of ESG fund style drift, which enables us to quantify the deviation of a fund's actual style from its declared sustainable objectives. Our analysis, based on panel and logistic regression techniques, reveals a significant positive relationship between ESG-drift and ESG fund's flow-performance sensitivity, with a dominant effect on fund flow from individual investors. Interestingly, compared with ESG funds that stick with their sustainability-oriented objectives, funds experiencing ESG-drift exhibit poorer returns, underperformance, smaller fund size, lower subscription rates, lower industry concentration, and lower fund flows, highlighting the crucial role of funds following objectives that prioritize sustainability. However, the ESG-drift does not significantly influence the fund's future performance. This paper provides pivotal insights into the complex dynamics between a fund's ESG commitment and its actual style, with important implications for enhancing ESG policies within the regulatory framework of the Chinese mutual fund market.