Do 'Good Guys' Finish Last? The Relationship between Morningstar Sustainability Ratings and Mutual Fund Performance

Given the rapid growth of investment products focused on socially responsible investing (SRI), in March 2016 Morningstar began reporting standardized metrics to “grade” the Sustainability (i.e., SRI) level of thousands of mutual funds. While traditional financial theory suggests funds that limit their investment universe should underperform, we find that funds with high Sustainability scores have about the same risk-adjusted returns (i.e., alphas) as other funds. Thus, investors can apparently follow a social mandate without sacrificing financial performance, particularly within the large-cap space. We also find that funds with high Morningstar Sustainability scores generally mimic those of self-proclaimed SRI funds, suggesting that the new metric opens up a larger pool of potential funds for investors focused on SRI. However, funds that specifically designate a social mandate do experience more stable cash flows, suggesting that the mandate may be more beneficial for the fund company than it is for investors