This paper examines the interconnections between segments of exchange-traded funds (ETFs), bridging the traditional financial perspective with the sustainability-driven approach based on the Sustainable Development Goals (SDGs) outlined in Agenda 2030. The analysis is endogenous, focusing on the shocks that emerge within the system composed of these segments. Utilizing daily data from six sustainable segments, each corresponding to different SDGs, alongside one traditional segment, spanning a sample period of approximately 14 years, the study reveals notable spillover effects. Specifically, the periods associated with the pandemic and the war in Ukraine were marked by a significant surge in information transmission across the segments. Furthermore, the findings indicate that sustainable segments exhibit a strong interdependence with their traditional counterparts, a dynamic that facilitates contagion risk and limits the effectiveness of portfolio diversification strategies.
Policy implications
- The interconnectedness of sustainable and traditional investments highlights the need for enhanced regulatory frameworks. These frameworks should closely monitor both markets and prevent financial contagion. Policymakers must ensure that regulations are flexible enough to address spillover effects, which could lead to systemic financial instability during times of crisis.
- Both traditional and sustainable markets are subject to the same macroeconomic and geopolitical risks. Therefore, policymakers should implement policies that address systemic risk across various financial sectors. These policies should focus on mitigating market contagion risks and ensuring financial market resilience, especially during periods of economic stress.
- There is a potential overestimation of the diversification benefits of sustainable ETFs in stable markets. Policymakers may need to take action to ensure investors are accurately informed about the potential risks, particularly in volatile conditions. This could involve strengthening consumer protection laws and enhancing transparency in financial markets to maintain public trust and mitigate the risk of financial losses.
- Policymakers and regulators should proactively develop crisis management strategies, such as the use of hedging instruments and the creation of more resilient market structures to reduce systemic risks during market disruptions.
- Policymakers should reassess the support and promotion of sustainable investments, taking into account their vulnerability to market stress. While there is a political trend favoring sustainable finance, it is essential to balance sustainability goals with realistic risk assessments to ensure that sustainability-driven policies do not unintentionally increase market vulnerability during crises.
Photo by Ravi Kant