Recently, as I reviewed my pension plan, I wanted to allocate funds to sustainable products, such as mutual funds with ESG characteristics (Environmental, Social, and Governance). However, navigating the world of sustainable finance is a complex and challenging task as sustainability declarations are lengthy and filled with jargon. In such a complex environment, investors’ knowledge about sustainable finance is essential, but unfortunately that this level of knowledge is low.
In a recently published working paper and policy brief, my colleagues and I developed a crash course in sustainable finance. In March 2024, we provided 2,000 Swiss retail investors with a text-based five-minute crash course on sustainable investing and analyzed their investment behavior through a survey experiment. The results showed that our participants significantly improved their knowledge after reading the educational material. Furthermore, they adjusted their portfolios by moving away from low sustainability mutual funds, opting instead for more highly sustainable funds. This investment shift was especially pronounced among participants who stated that they prioritized sustainability.
For retail investors, these products’ main appeal consists of aligning values with investments, while financial gains seem to be secondary. , it is unclear whether sustainable financial products perform differently than classic financial products. However, the beauty of sustainable investments lies not just in aligning personal values with investments – they also allow shaping society through market democracy, where individuals jointly create a demand for green business practices.
We developed a sustainable finance crash course
While reforming complex financial regulations like those in the EU is challenging, investors can alternatively improve their individual knowledge. We define Sustainable Finance Literacy as the knowledge and skills needed to make informed decisions about green financial products. Low sustainable finance literacy constitutes a significant barrier to green investments: In a study published in the Journal of Banking and Finance in 2024, we found that Swiss retail investors with low sustainable finance literacy tend to invest less in ESG products.
In response to low literacy levels, we distilled the essence of sustainable finance into a short text of less than 400 words. Our text explains the core concepts of sustainable finance with five slides. Three slides cover general concepts that apply to most financial markets worldwide. The remaining two slides cover the European Union’s (EU) specific regulatory framework. In the US, the Securities and Exchange Commission (SEC) is developing sustainability regulations resembling the European ones. Hence, the EU-specific explanations could be applied in a modified version to the US market.
To design our crash course, we worked with experts from the EU and the Swiss regulatory authorities, finance sector professionals, and academics. To ensure accuracy, relevance, and clarity, we continuously refined the course with expert feedback and tested with retail investors.
The three general dimensions address major misperceptions about sustainable investing and protect investors from common marketing exaggerations.
- Lack of Binding Standards: There are no binding standards by a regulator that define whether a product is sustainable; it is up to the asset manager to decide.
- Insufficiency of ESG-Risk Integration: ESG-risk integration alone is insufficient for a fund to be considered sustainable. For example, avoiding investments in flood-prone regions due to global warming mitigates financial risk but does not ensure sustainability.
- Impact Investing Misconceptions: Many investors mistakenly believe investing in low CO2-emitting companies directly reduces global carbon emissions. However, these investments occur in the secondary market and involve existing company shares. To influence CO2 emissions, one can invest in new ventures, like wind farms, or engage in shareholder voting to implement climate-friendly technologies.
The remaining two dimensions focus on EU regulations. The EU Sustainable Finance Disclosure Regulation (SFDR) is an early attempt to standardize the information mutual funds should disclose regarding their sustainability. Asset managers must gather and interpret data to fit into the EU’s three categories: brown, light green, and dark green. While these categories were not intended as a classification, the disclosed information is often used as a qualitative proxy for the greenness in the financial industry.
Our crash course highlighted the differences between light and dark green mutual funds under this regulation. Light green funds aim to maximize returns while incorporating sustainable characteristics, such as investing in low carbon emission firms, but without strict benchmarks. In contrast, dark green funds must provide concrete metrics showing alignment with sustainability targets, like the 2015 Paris Agreement. These funds also must ensure their investments do not significantly harm other sustainability dimensions.
In the United States, the SEC is preparing regulations like the EU’s Sustainable Finance Disclosure Regulation. The proposed regulations outline three categories of sustainable funds and require asset managers to disclose relevant information. However, a study by the CFA Institute from 2024 notes that the rule is still in the legislative process, so its final form remains uncertain. According to one of the CFA Institute’s study’s authors, the SEC proposal may encounter the same ambiguity issues that have affected the European rules. Consequently, while the U.S. still develops its own sustainability disclosure regulation, it appears to mirror the European framework. As a result, U.S. investors may face complexities like those experienced by their EU counterparts – calling for a solid understanding of sustainable finance.
Together, our crash course’s three general and two specific dimensions allow investors to identify whether a mutual fund is sustainable and, if so, assess its level of sustainability.
How we tested if the course changed behavior
Although we anticipated our crash course would be effective in theory, it was essential to determine if it actually assisted retail investors in selecting products that matched their values. To achieve this, we carried out a survey experiment with 2,000 retail investors from the German-speaking regions of Switzerland in March 2024. We randomly assigned some participants to read our educational material. Later, our survey featured an investment game designed to analyze the behavior of retail investors in financial markets. We also asked participants at the start of the survey if sustainability was a key factor in their investment decisions, which turned out to be true for half of them.
In the investment game, we provided participants with 1,000 hypothetical Swiss Francs (around 1,100 USD) to distribute among four mutual funds. They could choose to invest the whole amount in one fund or divide it among available options. The displayed funds were actual financial products selected to showcase varying degrees of sustainability in the market. Notably, we refrained from providing quantitative sustainability measures since these scores are often not comparable across different products, as shown by a study from Berg et al., 2022. Consequently, survey participants relied on qualitative information to assess a fund’s sustainability.
We developed a sustainable finance literacy index to evaluate how much participants learned. The index featured one question for each of the five dimensions outlined in our crash course. As expected, survey respondents who received the course performed significantly better on the five literacy questions. This result demonstrated our ability to teach these essential principles of sustainable investing; however, we needed to evaluate further whether this knowledge would influence investment behavior.
Here is what we found
Investors who participated in our crash course showed a 6% greater likelihood of choosing the most sustainable fund; this additional share of investors would have previously overlooked this fund and can be considered new clients. Once this group invested, their allocation matched that of participants who invested regardless of taking the crash course. These new contributions to the greenest fund came at the expense of reduced investment in the least sustainable option. Informed investors probably recognized their ability to align their values with the most sustainable fund following the course.
Overall, attitudes favoring sustainability emerged as the most significant factor in green investing. This pattern reinforces previous studies highlighting the importance of personal values in sustainable investment decisions. In our experiment, respondents who stated at the beginning of the survey that they valued sustainability were 20% more inclined to select a green investment. Furthermore, if they opted for a green fund, these participants would invest up to 17% more of their budget in the most sustainable option compared to those who did not share this mindset.
These green investors also reacted strongly to our educational treatment. If they took the crash course, investors who valued sustainability would invest more in the most sustainable fund. Conversely, they reduced the amount invested in light-green funds, indicating a shift from mid-range to high sustainability. Hence, we believe that the course taught investors that light-green funds often only appear green but often adhere to a minimum sustainability standard.
We conducted a deeper analysis of how investors perceived the sustainability of the four funds by asking them to give ratings for each product. Respondents who participated in the crash course rated light-green funds lower, whereas their views on dark-green and brown funds remained constant. This change could account for the decrease in investments by sustainability-conscious investors in light green funds, as they came to see them as less sustainable compared to genuinely greener alternatives. Unlike dark green funds, which provide clear benchmarks, light green funds often use ambiguous language concerning low CO2 emissions. Therefore, the crash course may help investors gain a more realistic perspective on these financial products.
Our analysis went further to understand how the crash course influenced a common investment behavior – return chasing. Findings from Tran and Wang, 2023, indicate that investors often rely on historical financial returns in determining present investment decisions. In a second experiment, we examined whether our course reduced this behavior. Participants were invited to make investment decisions after the returns shown were randomly changed. As expected, participants invested more in funds with higher past returns. But for the most sustainable fund, this effect was reduced by about 20% for the crash course group. This suggests that the course encouraged investors to prioritize factors beyond past returns.
Where do we go from here?
Sustainable finance can be challenging for retail investors due to unclear and complicated definitions. Often, investors who want to invest in green assets do not participate in this market or invest in products with exaggerated marketing claims. Our study showed that it is possible to help investors with a crash course in sustainable finance. We worked with experts to distill the essence of sustainable finance in less than 400 words. We tested our crash course with retail investors whose knowledge about sustainable finance increased substantially after taking only a few minutes to read through our educational material.
Investors who received our course were more likely to invest in highly sustainable funds and decreased their investments in brown products. For investors with sustainability-friendly values, this effect was more substantial. These environmentally friendly investors reduced their portfolio share in light-green products and increased their share of dark-green products. This shift could be attributed to a more realistic perception of light-green investments; receiving our course also led participants to pay less attention to past returns.
We showed that sustainable finance literacy is an essential skill for informed decisions in green finance, especially in the current unclear regulatory setting worldwide. A lack of knowledge in this dimension constitutes a significant barrier to investors who want to align their money with their values. While we saw that providing education helps in an experimental setting, the next step consists of making this material accessible to a broader audience, for example, through banks that could provide it to their clients.
Policymakers and financial institutions could focus on initiatives that enhance sustainable finance literacy for retail investors. This could include embedding educational modules in investment platforms or providing incentives for completing financial literacy courses. Offering a crash course in sustainable investing empowers consumers to make educated investment choices. This empowerment extends beyond personal preferences; in a market democracy, green investments enable people to collectively pool resources towards more sustainable sectors, which can directly shape our sustainable future.
Tobias Wekhof is a senior researcher at ETH Zurich. His works on sustainable finance and environmental economics, combined with methods from natural language processing.
