Greenomics – Series 2 | Ep. 1 | Shades of green: Retail investors’ sustainability preferences 

Sarah Nelson:

Welcome back to Greenomics, a podcast from Oxford Economics, where we delve into the complex relationships between climate, nature and our global economy. I’m Sarah Nelson, and today we’ll be discussing how retail investors feel about sustainability. Retail investors, So, that’s people like you and me, rather than the big institutional investors like pension funds. We buy stocks or bonds according to our investment preferences. So, we usually have preferences over risks and, of course, returns. But increasingly attention is turning to how we think about the green credentials of our investments. Joining me to discuss this are Andrej Gill, a professor of Corporate Finance at Johannes Gutenberg University Mainz, and Johanna Neuhoff, Director of Economic Consulting here at Oxford Economics.

Welcome to you both and thanks for coming on the show.

Andrej Gill and Johanna Neuhoff:

Very happy to be there.

Sarah Nelson:

Now, I know that you’ve just wrapped up a really interesting piece of work on investor preferences. Before we get into the nitty gritty, Johanna, can you just tell me what is sustainable investing?

Johanna Neuhoff:

So, I can give you the definition that the sustainable finance disclosure regulation puts on to sustainable investment, that is, investment needs to contribute to an environmental and social objective, and it does not significantly harm in environmental or social objectives. And moreover, the investee companies are to follow good practices in respect to management structures, employee relations, remuneration of staff and so on.

So, in short, it’s really about any investment into a economic activity that supports environmental and social objectives as well as follow, you know, the company needs to follow good governance. And our project really focused on environmental sustainability and the experiment and that the university did concentrated really on climate finance. So, one part of this sustainable investment definition.

Sarah Nelson:

Thank you. That’s really helpful. So Andrej, maybe can you please tell us more about this experiment in terms of that climate investment preferences that you’ve been running?

Andrej Gill:

Sure, sure. Very happy to do so. When we, let me basically start by saying that when we, when we are talking about an experiment, right, then this, this kind of experiments are not the experiments that many of the of the listeners may have in mind that we are in the lab, right? And we basically have some chemicals going on. But these experiments that we have in mind basically is understanding in a very controlled environment what people are actually doing. This entire experiment was designed to better understand how the individual investors as you were referring to it, right?

Not the big pension funds, but also this what we often call the household side, right? So the individual investors, how they make their decision about sustainable investments. And one of the key challenges in designing, but then also in understanding this question, right, is the difference between what we say are stated and revealed preferences, right? So it’s a big, big different if we ask people whether they want to invest sustainably or whether we are able to observe how they actually invest when real money is at stake. So, to tackle this, we used to behavioral experiment where participants were actually giving a budget and then asked to allocate it between a conventional and a sustainable financial product and to be able to carve out a little bit what their real incentives are.

We exogenously varied the expected return of the investments so to see whether people actually react to prices or whether they have like true standing deep preferences either to invest sustainably or not sustainably, regardless of say, the expected returns.

Sarah Nelson:

Thank you. That’s so interesting. I feel like that stated in real preferences, it’s like, you know, putting your money where your mouth is in a lab or in a in, in whatever environment you’re in. That’s really fascinating. So what did you find then?

Andrej Gill:

So, what we and let me let me really emphasize this, very many studies that are out there often look at say average behavior of people, right?

But what we really found is that, and this is something that I think cannot emphasize enough, that we know that people are different, right? But let’s also look at people being different with regard to their investment behavior when it comes to sustainable investments, right? So what we find is and we use some say more or less fancy machine learning technique on this, right, We could classify investor types into if you want to put it very, very say roughly into four different types, right. So, the one would basically be someone who regardless of the return somehow invests 50 50, right, about 50% in the sustainable investors, about 50% in the non-sustainable people.

We would then call them diversifiers maybe right. Then, then we have some portion of participants who invest nothing to very little into the sustainable one also regardless of the price, right. So, people we would maybe call them skeptics, right? Because they no matter how good the return of the sustainable investment actually is, they just stay with the non-sustainable investment one. Then we do have the ones that some would call them advocates, right? They regardless of the price, even if the return of the sustainable one is lower than the one on the non-sustainable, they regardless of the price to invest nearly everything into the sustainable investment.

And then we have those that would like the very classical finance 1-0-1theory would suggest, right, people do not have any sustainability preferences, right? They just react to prices. And do we see these people? Yes, of course we do see these people, right. So, they end this near to 0 into the sustainable one if the non-sustainable grants them higher returns and vice versa. So, they heavily react upon the price, right. So, these are like four more or less distinct types that we could get from this. And this is the important one from this individual data that we gathered through these incentivized experiments.

Sarah Nelson:

And did you find that there was, I mean, did you do the sort of stated preference stuff as well? So did you find the difference between people stated and revealed preferences to this experience experiment?

Andrej Gill:

I mean, I may combine this with other stuff that we already have been doing right a couple of couple of years ago or still ongoing other projects, right, where we do see again, it’s not a clear-cut answer, right. So, for some people, we do observe that they stay they want to invest heavily sustainable, but if you then put them into the in the environment that they actually need to invest their own money, they withdraw from that, right.

So, I find it super hard to say no, there are definitely this is just all green individual greenwashing, right. But do we observe individual greenwashing? Yes, for sure we observe right. So there is a bunch of people who actually tell you that they want to invest sustainable, but then if they actually need to do it, they do not right. And the key challenge I would say both research wise and policy and say consultancy wise is to disentangle this and come up with measures how we can actually have and understanding who are the people who actually invest sustainable, want to invest sustainable.

And I actually also may be willing to pay a higher price for investing sustainable to really have these say green preferences, if you want to call it like that.

Sarah Nelson:

Thank you. So your study which was testing that kind of, you know, what people really do in this environment, you found these four different types of investors or archetypes maybe of investors. Did you do any like correlations between their demographics or other features and those preferences?

Andrej Gill:

Sure. But if you have some, if you, if you look at these kind of experiments, right.

So, it’s the one thing that we have these say incentivized experiments. But for sure, while doing this, we also run like big surveys alongside, right? So, with the same people, right, asking them on their demographics, on their, say, political opinions, all of these things, right? So, the stated ones, right? And what we find is, yes, we do find that demographics play a role, right? I wouldn’t overemphasize this, right, because these are now say the descriptives behind these four types, right? But what we find is that, for example, the diversifiers tend to be a bit younger, right, and tend to have a lower financial literacy compared to other groups.

So, it may be the fact, right, that these people who have a 50 50 split more or less may also be the people that we may want to educate, right? Then we have the older investors, particularly those who are already retired are the ones that actually are the most maximizes. So, they react to the prices a lot. They have a high financial and environmental knowledge, but they, it seems to be that they are only willing to invest sustainably if the returns are competitive. So, to say, when it comes to say the skeptics, they, what we see, they tend needs to be really, really cautious on that because some of these are not statistically significant, but that tend to be having lower financial literacy, but paradoxically a higher awareness of ESG products.

So there’s also much more that we need to dig in. And then when we talk about, say, the advocates that nearly invest everything into the sustainable products, there we see something that we could also expect maybe, right. But it’s good to have the support of this that they support strongly, say government interventions, for example, in climate policy, right? So, these are say a rough idea on some of the interesting demographic correlations that we find last but not least in let’s say, more or less interestingly or surprisingly a bit right? Many studies find or show that women invest more sustainably than men.

We actually do not find this in our sample. OK, which I don’t think is like the most interesting one here, right? But it’s an it’s a nice idea that also they’re just having maybe a agenda split, maybe not enough to understand how people actually invest on markets.

Sarah Nelson:

That is really interesting because I’ve also, I’ve heard that that sort of split of the sort of women having stronger green preferences in terms of investing. But I was going to ask you if there was anything from the results that really surprised you, but maybe that was it. Was there anything else that kind of went against the, the, I mean the sort of experience you’ve had previous study?

Andrej Gill:

Yeah. So, the interesting one is that we also ask whether investors are willing to put money on the table to gather sustainability information, right? And we actually find they are, but despite this willingness, the additional information did not really influence their final investment decision, right. And then if I may combine this with other research that we have been doing right, we entirely focused on the role information played in the individual decisions. And then we see once this information actually is revealing information about the expected return, then it again can shift the say propensity on how people are actually willing to invest sustainably.

And maybe another unexpected result comes in the interface. So, we also asked experts outside the say, investment game how they actually think people do invest, right? So, both financial professionals, so representative of the industry, regulators, NGOs and policy makers. And they systematically underestimate the demand for sustainable investments, right? And this is something that I think calls for future research really to understand this better, how this misalignment of what people actually are doing and what the policy makers slash people from the industry think they, they do right? This wedge needs to be explained.

Sarah Nelson:

Yeah. Thank you. And that kind of quite nicely leads onto my next question which was for you Johanna on on Oxford economics kind of partnership in this in this project. So what did you find when you were looking into this?

Johanna Neuhoff:

Yes. So, our main role in the project was to really combine the academic findings with the practical challenges of stakeholders in sustainable retail investment finance. So, in other words, we really aimed to bridge the gap between the academic findings and their practical relevance and implications.

And as a starting point, you know, as we always do, we analyze the existing literature on the topic and also we identify key stakeholders facilitating sustainable investments for retail investment investors in Germany. So, what we did then to understand more about real world challenges, we conducted expert interviews with interviewees from banks, rating agencies, NGOs, customer protection organizations and international institutions. That is with all the relevant stakeholders that we identified during our desk research. And I think the interviews gathered some nice practical experience and standpoint on sustainable investments by retail investors, specifically for Germany, because we did it in in Germany. And just to showcase one very practical finding that might, you know, surprise policy makers, financial advisors and banks, for example, have to ask retail investors if they want to invest sustainably as per the European Markets and Financial Instruments directive two.

And if retail investors say they do not have any preferences for sustainable investments, they can choose any investment and also the bank advisor can just suggest any investment, even sustainable ones. Iif they signal, so the customer signals to have preferences for sustainable investments, they automatically restrict the investment options and also the one for the financial advisor. So consequently, what the vice has told us or recommended their customers behind closed doors is to state they had no sustainable preferences. And this leaves them more options to offer all kinds of products. And this has very practical implications for the current regulatory environment and also is maybe some part of the explanation on why people in the industry underestimate the preferences for green investments if they, you know, somehow, yeah, tend to, you know, convince people not to state their preferences.

And then just combining all these practical finance with the findings from Andrej’s group. And then we discussed them in two workshops with experts from the financial industry and academia. And then as a result, we drew conclusions of these combined findings for different stakeholder groups. And Andrej already mentioned his four groups, which are more like really machine learning based and, and you know, they are like clusters that we can find. And we just abstracted them a little bit more and say, OK, in the end we have three different type of investors, the grey investors that tend to have neutral or even hostile attitude towards sustainable investing.

And these are like 15% of the people that we have looked at just to give you know how big is the group in the end. Then we have the light green investors. They prioritize returns but are also interested in sustainability. So, there may have the potential to be drawn towards sustainable investment, but their primary motivation remains financial. And this is more like the diversifier group that Andrej talked about and they are 58%, so the largest group that we could find. And then we have the dark green investment that have really green preferences as, as we say, they are primarily concerned with the impact of the investments and are really willing to take on more risk to achieve that goal.

And which is nice, while we’re not explicitly link that to the SFDR regulation, these type of investors align quite well with the different types of investments as per Article 6, 8 and 9 of the SFDR. So it’s quite interesting that actually the regulation already somehow implemented that kind of different preferences. And then of course from that you can say what does that help us, you know? So, for Gray investors, it’s really unlikely that they contribute sustainable financing solely due to the preferences for sustainability. But for the other two groups, of course, you can do something. And the largest group of retail investors, So the light green investors, they generally prioritize the returns but are also interested in the sustainable options.

But the complexity of the many definitions of sustainability, the range of products and the diverse sustainability ratings can overwhelm them. So, there’s just a call for simplicity and clearer regulations for them and conversely, the dark green investors. They are willing to engage with the complexity and they really want to delve deeper into the specifics of sustainability just to make sure that the investments actually have impact. So, then in the end, we really thought about what does that mean then for the sustainable retail community because financial investors, the media, consumer organizations and the government, of course, they all can have a crucial role in leveraging this knowledge to attract more retail investors for sustainable funds.

Sarah Nelson:

So that’s all super interesting. And you know, one of the things that I’ve come across is that just waterfall of information and ESG ratings and it’s really hard to understand what they all mean. I guess one of the things, so I mean we’re recording this a week after the omnibus ruling kind of thing came out, which as I understand is mostly on corporate, on sort of corporate sustainability reporting. But then that obviously flows on to finance. I think that’s right, but you can correct me if I’m wrong.

So, what do our kind of, or your findings on this experiment mean for policy makers come in the context of that slight rollback on corporate sustainability reporting?

Johanna Neuhoff:

And so I think first and foremost, it’s really that the results indicate how regulations could be improved by following a more user centric approach. So really looking at which type of investors do we want to tackle, which type of investors can we reach. And then for example, for the largest group, as I said, the light green investors, it’s important to inform about sustainability standards. So, I think the EU taxonomy for sustainable activities is a first step in the right direction.

But then again, there has been quite some discussion, especially in Germany, which parts are considered green investments, for example, nuclear energy and stuff like that. So, it’s just to make sure this is a type of green or sustainable investment. These are our minimum standards, and we just have to inform what’s in there and what’s not. So even if it’s not the perfect definition for all these types of investments, I think for the light green ones, it just meets the tag sustainable. So here just, you know, these standards and a clear taxonomy, taxonomy for sustainability ratings. This is just something that policy can support the light green investors to you know, act or to invest more in sustainable funds.

Just one addition because Andrej mentioned this green washing in the beginning. So, I think it’s also important to understand that if you provide these standards and that a lot of these light green investors, they somehow betray themselves. So, it’s also good to have some kind of minimum standard or a higher minimum standard just to make sure that it’s not a usual investment, that it’s really a green investment. Because in the end they are only interested in the tech and they wouldn’t really dig deep into the information whether it’s actually a green investment or not. So, it’s not the role of this retail investor to do that, but rather of the regulation itself.

Then I think it’s also something that government can just lead information campaigns to really enhance the investor trust and also relieve the burden on financial advisors by just simplifying the sustainability landscape for both types of green investors. And then the end for the dark green investors, In the end, just products are missing, right? So, there are not real impact investment opportunities for them. And while this is not the governmental role to come up with new products, it’s still relevant to notice when communicating existing taxonomies or standards, right? So, in conclusion, I think regulations can just help to make it clearer, simpler and more credible for retail investors to sustainable invest if you understand the preferences a bit better.

Sarah Nelson:

Yeah. Thank you. Well, hopefully this research contributes to that and it sounds like it does. I think Andrej, a question for you on the take away side and you touched on this before, but that you know, the industry doesn’t necessarily have an accurate perception of retail investors preferences. So, what does that mean for retail investors and why does that matter?

Andrej Gill:

Yeah. No, I’ve been, it definitely matters. Just to combine this maybe with Johanna’s last point, right.

I mean, if we want to have say functional regulation, right. So that really, I mean what’s the idea should be that if individuals have certain type of preferences, they need to find the products they actually want to invest in, right? And there are say two or three very main important factors behind this. I would say the one is what Johanna was already referring to is I mean it has to be a clear-cut regulation, right? What we do not want to have is basically still people try to fool themselves, telling them that they invest sustainably, but they rather just go for the highest return, right?

And so, the way I understand the regulation these days is that at least there is room for improvement right to do so. The second is what you were referring to is do we actually see that the people who actually are responsible for the regulation/for the product, do they have the say correct understanding of the preferences of the individuals, right. And what I was already referring to a bit earlier is that what we see not really, right? So, what the experts actually tend to assume that most on, of the investors behave, behave if they were behaving like maximizers, right?

So, they, they really go for the one with the highest return, right? So, but in reality, what we found is that especially they say advocates, right? They really are willing to invest sustainably even if the returns are lower, right? And at the same time, and this is even say, I would not say more worrying, but also a bit worrying, right, is that experts overestimate how much investors actually understand about sustainable finance, right? So, they really think that people have a roughly a good understanding, right? What we do not see across all of these investors, and this could lead, I’m not saying that it does, but it could lead to misguided product offerings, ineffective communication strategy by the regulator and so on, right.

And then may as a finer word on this, right, Why does this matter at all, right? And now I would say, well, it matters because say if the financial institutions misunderstand the investors preferences, they might actually not offer the right products, OK. And right products not meaning here that say return maximizing for the bank, right. But I think there’s on both sides room for improvement. So, to make the individual investor more happy and have the product better aligned with their true preferences and they were also being able to actually come up with products that right now do not really exist, right. So, if banks, for example, right, might focus too much on the on this idea that we only talk about returns when we talk about sustainable product, then it may for some people actually be not that important at all, right?

So, what they really want, and I’m again, not saying everyone, but this one portion of investors who really has this very strong preferences, they actually may be super willing to accept slightly lower returns. But one has to be open about this I think.

Sarah Nelsom:

And there has to be sufficiently, you know, useful information for them to make those decisions well informed. Andrej Gill:

Yes, absolutely, absolutely. And it has to be as Johanna was referring it, it has to be a clear-cut information, right these days, right, Whether or now it’s about ESG standard, it’s about SFDR regulation, whether it’s about say the different EU alignment goals when it comes to the two degree goal, right?

I mean, this is all so confusing, right? That on the one hand, I think it hinders individuals to invest sustainably, but on the other hand it open up a room to fool yourself that yeah, yeah, yeah, I still invest sustainably regardless that it’s in the end maybe super non sustainable, right?

Sarah Nelson:

Yeah. Well, thank you so much for describing that experiment and those really useful insights, both of you. One final question for me, which is where can people find out more and do they have to speak German to do?

Johanna Neuhoff:

So, I mean, we have published the most in German, I have to be frank, but we have on the Oxford economic side, a translation of the project itself and also block article that summarizes some of the findings.

And Andrej, I think you’re working on the academic paper, which is probably in English, so people can wait for that.

Andrej Gill:

No, absolutely. So, so we will, we will have, so basically on my website, on the website of other ones on the team, right, you’re going to find our work, which is entirely written in English anyways. So very much looking forward to also talk about this.

Sarah Nelson:

Fantastic. Well, we will put those links to the German and the English sort of summaries on in the show notes so listeners can find out more if they for desire.

Thank you so much, Johanna and Andrej too, for coming on the show today and sharing the results of this really interesting study.

Andrej Gill:

Thank you.

Johanna Neuhoff:

Thank you for having us.

Sarah Nelson:

That’s it for today on Greenomics from Oxford Economics. TuneIn next time for discussion on how supply chain risk can ripple through into financial markets. My team has actually just published an interesting research brief on this, and we’ll also put that in the show notes along with a link to Johanna and Andre’s work. Thank you for joining us.