Climate risk, ESG ratings, and the flow-performance relationship in mutual funds

We extend the burgeoning literature on climate finance by examining the informational role of mutual fund sustainability ratings on the asset allocation decisions by investors when faced with climate risks. Utilizing data on a large sample of equity mutual funds in Australasia (Australia and New Zealand), we find that climate risk plays a significant role on the sensitivity of fund flows to past performance. We find that the sensitivity is stronger for mutual funds that enjoy high sustainability ratings, and we show that the informational value of past performance over subsequent fund flows becomes more important when investors face greater climate risks. We argue that sustainability ratings of managed funds not only complement performance but also help improve the efficiency of asset allocation decisions, more so during a heightened climate risk environment. • Higher climate uncertainty increases fund flow sensitivity to past fund performance. • ESG ratings serve a dual role: as an indicator of the fund manager's preference for sustainability and as a complement to performance. • Fund flows in response to past performance are stronger for funds with high sustainability ratings. • Transition risk dampens the flow-performance relationship, particularly for funds with poor sustainability ratings.