This paper examines the benefits and costs of greenwashing in mutual funds. We identify greenwashing funds by analyzing their ESG-related disclosures using large language models (LLMs) alongside their actual green investments. We find that greenwashing funds charge higher fees while attracting greater investor flows. Moreover, investors appear more lenient and less sensitive to poor performance in greenwashing funds, incentivizing underperforming funds to adopt this practice. However, greenwashing funds face higher regulatory and reputational costs, as reflected in ESG-related SEC comment letters and subsequent investor outflows. Finally, institutional and retail investors respond differently to greenwashing behavior.

This paper analyzes the impact of disclosures of sustainable investment targets under the EU Sustainable Finance Disclosure Regulation (SFDR) on mutual fund flows. Using a staggered difference-in-differences setup and focusing on retail-oriented index funds, we find that sustainable investment targets have a temporarily positive impact on fund flows in comparison to funds without sustainable investment targets. Furthermore, we find a negative linear relationship between sustainable investment targets and fund flows. While lower targets attract higher fund inflows, higher targets result in significantly lower or even no inflows. Our results suggest that up to a target level of 20% in sustainable investments, index funds can attract more inflows. This suggests a trade-off between sustainability commitments and performance considerations.