This paper proposes a new measure of ESG-specific skill based on the relationship between deliberate trading decisions of mutual fund managers and ESG rating changes. We differentiate between proactive managers, whose trades predict future changes in ESG ratings, and reactive managers, who change their portfolio allocation after a change in ESG ratings occurs. The predictive ability of proactive managers is persistent in out-of-sample tests, consistent with them being skilled. For identification, we rely on an exogenous methodology change of one ESG rating provider. The shock changed the level of ESG ratings without releasing new information. Reactive managers significantly change their holdings in firms whose ESG ratings exogenously change, consistent with them not having ESG skill. Proactive managers did not trade in the direction of the change, consistent with them trading on information. ESG skill has economic implications: Investors in mutual funds with an explicit sustainability mandate reward proactive managers with 70bp higher average monthly flows.

Many individuals delegate their investment decisions to professional asset managers that may have very different preferences. We study the differences in sustainability preferences between individual and institutional investors using the universe of holdings in bonds traded in Norway 2010-20. Our data includes many individuals as well as financial investors --fewer but with larger stakes. We identify sustainability investors as those that choose Green bonds over similar non-green bonds by the same issuers and compare them to those that choose the latter over the former. Although Green bonds only constitute a small fraction of portfolios, their investors exhibit a distinct investment strategy. In theory, the utility derived from green preferences allows investors to take on more financial risk. We show that financial investors in Green bonds do not behave this way, but individual investors do: they hold riskier portfolios with higher volatility and more defaults. Our results suggest that individual Green bond investors have non-pecuniary green preferences, but are not representative for the majority of sustainable investment in the market.

We use new data on the ownership of mutual funds in Europe to estimate how investors respond to regulations on the disclosure of Environmental, Social and Governance (ESG) performance. We find that the introduction of ESG disclosure rules for mutual funds led to strong flows into funds categorized as green. We show that investor rebalancing takes place through an uncertainty channel where investors value the lower uncertainty, and a greenness channel where funds respond to disclosure rules by increasing their greenness to attract flows. We find empirical support for both channels: green funds for which investors had little information before the regulation experience the strongest flows, and green funds that had a low ESG rating before the regulation decrease their emissions most under the new rules.