Market-Implied Sustainability: Insights from Funds' Portfolio Holdings

Abstract

In this work we propose a framework to construct Market-Implied Sustainability (MIS) scores for individual firms by exploiting fund-level sustainability classifications and granular portfolio holdings. The central idea is that the relative over/under-representation of a stock in sustainability-oriented funds reveals a market-based assessment of its sustainability profile. We implement the methodology in the European context using the Sustainable Finance Disclosure Regulation (SFDR), considering Article 9 (``dark green'') funds as the sustainability-oriented segment and comparing their portfolio compositions to those of other funds. We compute MIS scores for a large cross-section of European companies over the period 2010--2025. We then examine how MIS relates to traditional firm-level ESG ratings provided by LSEG and analyze the determinants of potential divergences between the two measures. Finally, we assess the economic relevance of MIS through portfolio-tilting strategies, ranging from rule-based reallocations to constrained optimal allocation frameworks. The results show that MIS scores capture dimensions of sustainability that differ systematically from conventional ESG ratings. In portfolio applications, tilting toward firms with high MIS scores improves risk-adjusted performance, whereas strategies based solely on ESG ratings do not deliver comparable gains. Overall, the findings suggest that market-implied sustainability measures provide complementary information to fundamentals-based ESG metrics and have practical relevance for asset allocation and regulatory monitoring.