ESG impact on oil and natural gas financialization through price transmission

Oil and Natural Gas markets are integrated with equity markets over time. While the integration characteristics vary between type, direction, and magnitude, this persistent relationship yields questions about oil's and natural gas's place in diversified portfolios. Since general equity markets are observed to integrate with these specific energy commodities, similar relationships are expected with diversified equity mutual funds. In recent years, the Environmental, Social, and Governance (ESG) characteristics of firms have attracted attention from the market participants. Firms' ability to incorporate policies and procedures that are mindful of ESG dimensions is suspected to influence investor and manager decisions. In this study, we first test different integration levels between diversified equity mutual funds and oil and natural gas markets. After identifying these relationships, we test whether ESG components of funds impact the probability of integration. Our results provide evidence of strong integration. More importantly, we show that ESG's impact on integration differs between diversified equity fund flows and returns.