The <scp>ESG</scp> Backlash and the Demand for <scp>ESG</scp> Mutual Funds

ABSTRACT The backlash to ESG investing is in full swing, with dozens of states enacting measures aimed at curtailing the consideration of environmental, social, and governance factors in their pension funds. Meanwhile, ESG mutual funds are experiencing net outflows after a period of lagging performance. Is this the end for ESG funds? This paper draws on the literature on mutual fund flows to study how the demand for ESG funds has changed over time and how that demand interacts with the political and legal backlash to ESG. It finds that ESG funds received significant positive flows, controlling for conventional predictors of fund flow, starting in 2017. This effect peaked in late 2019, much earlier than the publicly perceived decline of ESG. Abnormal investor preference for ESG funds disappeared in 2020, around the time of the Trump Department of Labor rule targeting ESG and then reappeared in 2021 before declining again. The excess demand for ESG was driven largely by institutional share classes, particularly pre‐2021. While the positive effect of ESG branding on flows has disappeared, demand for ESG funds (controlling for past performance) has generally remained non‐negative up to 2024. Most of the decline in excess demand for ESG funds predates the political backlash and state anti‐ESG laws. Tests for a causal relationship between ESG fund flows and the political backlash, as measured by mentions of ESG in conservative media and state laws restricting ESG, show no statistical connection.