If sustainability labels are supposed to guide us toward a greener future, how can we ensure they’re not leading us astray? Professor Sofia Ramos of ESSEC Business School and her fellow researchers dive deep into the world of sustainable investing, uncovering the hidden complexities of signalling of third-party certifications, ESG ratings, and self-declared claims. 

The Hidden Complexity of Sustainability Labels: Are Investors Getting Mixed Signals by Anshuman Sisodia. Related Research: Ramos, S., & Wüstenhagen, R. (2024). Sustainability labels in mutual funds: Do third-party and self-declared signals align? Business & Society. Advance online publication. https://doi.org/10.1177/00076503231204613

The Challenge of Selecting Sustainable Investments

Imagine walking into a store to buy a sustainable product, only to be overwhelmed by the sheer number of choices. Some products boldly claim to be sustainable, while others don’t mention it at all. Even worse, you can’t be sure if the ones labeled “sustainable” truly are. This confusion isn’t far from what investors face when trying to choose sustainable funds. With so many options and labels, how do you know which ones to trust?

In the world of sustainable investing, investment funds use a variety of signals to showcase their sustainability credentials. Some carry third-party verified labels, others self-declare their sustainability, some classify themselves under Article 9 of the SFDR (Sustainable Finance Disclosure Regulation), and still others are rated by agencies like Morningstar and MSCI. But instead of simplifying the decision, this abundance of labels and identifiers often creates more confusion. Which cues are reliable? Which ones truly reflect a fund’s sustainability?

The problem doesn’t stop there. Even when these signals exist, they don’t always align. For instance, a fund might have a Government or Non-Profit Organization (GNPO) label, indicating it meets high sustainability standards, but its ESG ratings might tell a different story. This misalignment doesn’t just create confusion—it undermines trust in the entire system of sustainability labeling.

Why This Matters

Sustainable investing is booming. In 2023, Europe leads the world in sustainable fund assets, with investors pouring billions into funds that promise to do good while doing well. But with so many labels and certifications, it’s easy for investors to get confused—or worse, misled.

If labels don’t align with actual sustainability performance, investors risk supporting funds that don’t live up to their promises. This undermines trust in sustainable finance and could slow the flow of capital to genuinely green initiatives. To address these challenges, Professor Sofia Ramos of ESSEC Business School and her team set out to study the alignment of sustainability signals in European mutual funds. Their research aims to provide clarity on which signals investors can trust and how these labels shape the sustainable investment landscape.

The Role of Signalling Theory in Sustainable Investing

The study is grounded in signaling theory, which explains how cues and indicators are used to convey the credibility of a particular attribute guiding decisions. In the context of sustainable investing, signaling helps bridge the information asymmetry between fund providers and investors. While investors often lack the expertise or resources to assess a fund’s true sustainability credentials, labels act as signals that communicate these attributes, simplifying the decision-making process. For example, a third-party certification or a high ESG rating can signal that a fund meets certain sustainability standards, helping investors identify funds that align with their values.

However, for these signals to be effective, they need to be aligned. Alignment refers to the consistency between different types of sustainability signals—such as third-party labels, self-declared classifications, and ESG ratings. When these signals align, they reinforce each other, building trust and clarity for investors. But when they don’t, it creates confusion and undermines the credibility of the entire labeling system. This is why understanding the alignment—or lack thereof—between different sustainability signals is crucial for both investors and regulators.

To investigate these questions, Professor Ramos and her team employed a comprehensive methodology. They compiled a dataset of sustainable equity and fixed-income funds sold in the EU, focusing on funds with third-party labels (such as GNPO certifications) and self-declared signals (like SFDR Article 9 classifications or ESG-related fund names). The researchers then analyzed the alignment between these signals and ESG ratings from commercial providers like Morningstar and MSCI.

The research uncovers a range of fascinating insights into how sustainability labels align with ESG ratings and other signals, offering valuable clarity for investors navigating the complex world of sustainable finance.

GNPO Labels and ESG Ratings: A mixed message

When it comes to the alignment between GNPO labels and ESG ratings, the results paint a nuanced picture. On one hand, equity funds with GNPO labels show a strong alignment with higher ESG ratings from providers like Morningstar and MSCI, reinforcing the idea that these labels serve as effective signals of sustainability. On the other hand, fixed-income funds demonstrate less consistency in this regard. This discrepancy likely stems from differences in how ESG risks are assessed for equities versus bonds. While ESG methodologies for equities are well-established, those for fixed-income funds are still evolving. As a result, fewer fixed-income funds have ESG ratings, leading to weaker overall alignment.

The study also explores whether funds with multiple GNPO labels are more likely to exhibit other sustainability signals. The findings support this hypothesis, revealing that funds with multiple GNPO labels tend to have higher private-sector ESG ratings, Article 9 classifications, and ESG-related names. This pattern holds true for both equity and fixed-income funds, further emphasizing the value of multiple certifications as a robust indicator of sustainability.

Self-Declared Signals: Enhancing transparency and credibility

The research also investigates how GNPO-labeled funds align with self-declared sustainability signals, such as SFDR Article 9 classifications and ESG-related fund names. The results show that GNPO-labeled funds are more likely to be classified as Article 9 and include ESG terminology in their names. Interestingly, fund names with ESG-related terms emerge as a meaningful cue for sustainability, particularly for funds with GNPO labels, government certifications, multiple labels, or top ESG ratings. This alignment not only strengthens their credibility but also suggests that these funds are committed to sustainability and transparent in communicating their efforts to investors.

The Critical Role of Third-Party Labels

One of the most significant takeaways from the research is the critical role of third-party labels, such as those issued by governments or nonprofits, in not only reflecting but also boosting sustainability credibility. Funds with these labels, particularly GNPO-labeled equity funds, are more likely to achieve higher ESG ratings and improved Morningstar ratings over time. This demonstrates that these certifications act as genuine signals of quality and sustainability, rather than mere marketing tools. Importantly, government-certified and multiple GNPO-labeled equity funds are more likely to receive top-tier ESG assessments, further highlighting the value of these labels. By distinguishing truly sustainable funds from those that may only appear to be, these costly, third-party certifications help build investor trust and provide clearer guidance in the often-confusing landscape of sustainable investing.

Transparency Builds Trust

The research underscores the importance of GNPO labels as credible signals of sustainability, particularly for equity funds. However, it also reveals hidden complexities in how sustainability labels align—or fail to align—with other signals like ESG ratings and self-declared classifications. These findings provide deeper insights for both investors and regulators, highlighting the challenges of navigating a market flooded with competing sustainability claims.

The study brings us full circle to the opening scenario: just as a shopper faces confusion when choosing a sustainable product, investors grapple with a maze of labels and signals when selecting sustainable funds. The findings remind us that while labels can be helpful, they are not infallible. By understanding their nuances and limitations, we can make more informed decisions—whether at the store or in the financial market.

Prof. Sofia Ramos

Useful Links :

• Connect with Prof. Sofia Ramos on LinkedIn
• Read a related article: Trends in Green Finance and Investment
• Discover ESSEC Business School
• Apply to ESSEC MBA

Learn more about the Council on Business & Society

The Council on Business & Society (The CoBS), visionary in its conception and purpose, was created in 2011, and is dedicated to promoting responsible leadership and tackling issues at the crossroads of business and society including sustainability, diversity, ethical leadership and the place responsible business has to play in contributing to the common good.  

• Follow the CoBS on LinkedIn
• Download magazines and learning content from the CoBS website downloads page.

Member schools of the Council on Business & Society.

• ESSEC Business School, France, Singapore, Morocco
• FGV-EAESP, Brazil
• School of Management Fudan University, China
• IE Business School, Spain
• Indian Institute of Management Bangalore, India
• Keio Business School, Japan
• Monash Business School, Australia, Malaysia, Indonesia
• Olin Business School, USA
• Smith School of Business, Queen’s University, Canada
• Stellenbosch Business School, South Africa
• Trinity Business School, Trinity College Dublin, Ireland
• Warwick Business School, United Kingdom.