Driven by Returns, Responsibility, or Recognition? How Investor Behavior and Return Gaps Differ Between Sustainable and Other Exchange-Traded Funds

Abstract

This paper investigates the “return gap” – the difference between reported fund returns and investors’ actual realized returns – in relation to sustainable exchange-traded funds (ETFs). The return gap reflects behavioral inefficiencies, often caused by investors’ reactions to market fluctuations, that cost investors billions of dollars annually. Using over 64,000 global ETF-year observations from 2006 to 2023, I analyze how sustainability, past performance, volatility, and key ESG (environmental, social, and governance) events shape investor outcomes through pooled panel OLS (ordinary least squares) regressions. Results show that sustainable ETFs are associated with significantly lower return gaps – and therefore better realized returns for investors – from 2017 to 2021, a time when ESG funds gained popularity, suggesting more stable and better-timed behavior among sustainable investors. On average, investors in sustainable ETFs actually outperform their funds’ reported returns. In contrast, ETFs not labeled as sustainable exhibit larger return gaps, reflecting more erratic, return-chasing investor behavior. However, the return gap for sustainable ETFs widens after 2021, coinciding with increased media scrutiny and weaker ESG performance. These findings suggest sustainable investment frameworks may help attenuate behavior-driven losses, though their effectiveness depends on market sentiment and media narratives. This paper aims to help clarify how sustainability influences investor behavior and realized returns, with implications for ESG policy, fund design, and long-term financial and social goals.