Green ETFs: Does Addition of Green Bonds in Portfolio Affect Pricing?

The integration of environmental, social and governance (ESG) factors into the investing process is underpinned by the growing popularity of sustainable development strategies and global concerns regarding the environment. However, scholars are not in agreement about whether ESG investing obliges an investor to sacrifice financial returns, does not affect the performance of financial entities, or can improve it. Such investing can be done using different financial instruments. This study deals with one of those instruments – exchange-traded funds or ETFs. These funds are one of the most prospective investment vehicles because of their special properties. Moreover, ESG ETFs are being popularised, and they demand attention from both practitioners and academia. However, existing studies concerning ESG ETFs are rather scarce, and they focus on performance measured by risk-return characteristics. This paper addresses that gap in the literature and investigates a special financial issue that has not been discovered in the case of ESG ETFs – whether such funds can attract more financial flow than their conventional counterparts – which may reflect investors’ demand for ESG ETFs. In particular, this study examines the relationship between the inflows to such funds and their compliance with ESG criteria, using two types of regression models. First, it exploits cross-sectional data on bond and equity ETFs traded in the U.S., and it investigates the relationship between higher ESG scores and higher inflows. Second, the study uses historical data on U.S. bond and equity ETFs in 2- and 3-year periods, and it applies pooled OLS and mixed effects models to panel data samples of ESG and non-ESG ETFs distinguished by a dummy variable. The positive relationship between financial flows and ESG score was partially proved: a statistically significant and positive coefficient of variables representing ESG scores was observed in the case of the equity ETF model. However, its value was too modest to draw any meaningful conclusions. In the model for bond ETFs, no such evidence was found. This might be because of the small size of the sample and other methodological weaknesses. On the contrary, in all specifications operating different samples of panel data dummy variables representing ESG labelling had relatively high, positive and statistically significant coefficients. To be precise, on average, compliance of ETFs with ESG criteria may promise 2.1-3.5% of additional inflows. This is in line with other ESG fund literature, e.g. studies dealing with mutual funds. This result gives a strong market signal to ETF providers, other market participants and policy makers; it contributes to the dilemma regarding the financial impact of ESG factors, and it opens up many directions concerning financial properties and other specificities of ESG ETFs. Several implications for the broader literature on exchange-traded funds also are identified and discussed. At present, there are still many limitations to this type of research. However, as more ESG ETFs emerge – those limitations can be overcome. This paper provides a strong background for further studies in this area, and it suggests possible improvements for later studies.