Relationship between funds’ ESG ratings and Lipper rankings

PurposeThe purpose of this paper is to investigate how ESG ratings ultimately affect funds' financial performance after considering the endogenous choices funds make to maintain social responsibility. We specifically analyze the financial performance of funds with varying ESG ratings using the Lipper fund ranking system.Design/methodology/approachWe analyze the effect of investment funds' ESG ratings on their financial performance, measured by Lipper ratings for expense, consistent return, capital preservation and total return. We use ordered logistic regression to examine the impact of ESG scores on Lipper rankings in a cross-sectional data as of 2022.FindingsOur findings suggest that an increase in a fund's ESG ratings is associated with lower operating expense in general, although funds that market themselves as “green” or “ethical” have significantly higher operating expenses. Furthermore, after controlling for endogeneity, the impact of ESG rating on mutual fund's risk-adjusted financial performance is significantly positive and high-ranking ESG funds are more likely to preserve capital.Practical implicationsOur results suggest that higher costs associated with “green” and/or “ethical” labeled funds are not justified since higher ESG ratings does not command a higher expense on average. The financial performance of high ESG funds outperforms similar funds in its benchmark group.Social implicationsInvesting in funds that have higher ESG records is not necessarily more costly, and the financial performance of such funds is not lacking compared to counterparts. Thus, greater management fees charged by funds that classify themselves as “ethical” or “socially responsible” might not be justified.Originality/valueThis study contributes to our understanding of the effect of ESG ratings on fund characteristics and performance through the perspective of Lipper ratings.