Loss aversion trumps social trust in times of financial crisis

Socially responsible investing (SRI) has attracted significant demand in recent decades. Academic research is supporting this trend with a growing body of literature on SRI. However, the published research has a limited focus on equity funds and on the topic of performance. This paper therefore extends our knowledge of SRI by investigating fund flows of fixed-income funds. Flows are a particularly useful dimension of fund analysis because they reveal the underlying motivations and preferences of investors. Fixed-income funds represent an important asset class to understand because of their risk mitigating role in times of financial instability. This paper considers SRI fixed-income fund flows in periods of financial crisis and compares with the flows observed in more regular financial periods. A large sample of fixed-income funds (spanning 2001 to 2019) is analysed with particular focus on flows during the Global Financial Crisis (GFC). This sample is analysed to test for the existence of “social trust” by investors. There is some evidence of social trust by investors during the GFC (Dong et al., 2019; Lins et al., 2017), however, that evidence is in the context of equity investments. This paper contributes to the literature by testing for the existence of social trust during the GFC in the context of fixed-income funds. Specifically, we investigate whether “social trust” increases in times of financial crisis. An increase in trust would be evident by higher fund flows to SRI compared to conventional funds. The results show a significant "flight-to-safety" into fixed-income funds during the GFC. However, during this re-allocation of investment exposure, there was a noticeable lack of preference for SRI fixed-income over conventional fixed-income funds. This suggests, during periods of market dislocation, investors are primarily concerned about financial loss rather than concerned about social trust. In contrast, during the more regular financial market conditions following the GFC, there are significantly more funds flowing to SRI fixed-income funds compared to conventional fixed-income funds. This suggests investors hold greater concern for social trust in periods of normalcy. Investors potentially have greater scope to consider more intricate decisions, such as socially responsible concerns, when not distracted by the prospect of substantial financial losses. Dong, X., Feng, S., Parida, S., & Wang, Z. (2019). Corporate Social Responsibility Exposure and Performance of Mutual Funds. The Journal of Investing, 28(2), 53-65. Lins, K. V., Servaes, H., & Tamayo, A. (2017). Social capital, trust, and firm performance: The value of corporate social responsibility during the financial crisis. the Journal of Finance, 72(4), 1785-1824.