While fund managers’ ESG considerations are often considered a “labelling” exercise, a recent paper in the Journal of Banking and Finance suggests it can actually help the price discovery process. And, in doing so, improve the cost of capital for greener companies.
What the Study Looks At
The paper by Avramov et al. (2026) studies actively managed equity mutual funds in the United States over the period 2007–2021. These are traditional mutual funds where portfolio managers actively select securities and hence deviate from benchmarks.
Such fund managers differ in how much they care about ESG, and those differences affect how they work.
Managers whose investors place greater weight on sustainability:
- spend more time and resources acquiring ESG-relevant information,
- analyse firms more deeply across environmental, social, and governance dimensions, and
- do so particularly for companies that are clearly “green” or clearly “brown”.
This is not a free exercise. ESG information is complex, noisy, and often harder to interpret than traditional financial data. But managers with stronger ESG preferences are willing to incur these costs because ESG outcomes matter to their investors.
More ESG Information Means Better Pricing
This additional effort supports the price discovery. The study shows that stocks held by funds with more heterogeneous ESG preferences are priced more accurately. In technical terms, prices become more informative — they better reflect future fundamentals.
This effect is strongest for:
- companies with very strong ESG profiles, and
- companies with very weak ESG profiles.
Why? Because these are precisely the firms where ESG-motivated managers concentrate their research efforts. As more private information is incorporated into prices, valuation accuracy improves.
For greener companies in particular, this leads to a lower implied cost of capital, not only because investors like sustainability, but because uncertainty about future cash flows is reduced through better information.
Valuation implications
When valuing a fund, it is hence important to understand its ESG preferences. If ESG preferences shape how fund managers acquire information, it becomes a core input into the valuation process itself.
When valuing a fund, it is therefore essential to understand its ESG preferences and how they are implemented in practice. Doing so allows a valuer to properly assess:
- what information has gone into asset selection,
- how valuation judgements may differ from conventional benchmarks, and
- how robust the fund’s valuation framework is when ESG conditions or investor preferences change.
Reference
Avramov, D., Cheng, S., & Tarelli, A. (2026). Active fund management when ESG matters. Journal of Banking and Finance, 182, 107597.
https://doi.org/10.1016/j.jbankfin.2025.107597