Fund Solutions

EU Sustainable Fund Launch Activity to Rebound

Sustainable product development fell to a historic low in Q1 2023, driven by regulatory and macroeconomic uncertainty.

Inflows and product development in European sustainable funds “cooled down” in Q1 2023, but activity is expected to pick up after asset managers were given greater clarity on the Sustainable Finance Disclosure Regulation (SFDR).  

Net inflows into European sustainable funds were US$32.3 billion in Q1 this year, down from US$40.3 billion in the previous quarter, according to a recent Global Sustainable Fund Flows report by Morningstar. Q1 European sustainable funds attracted approximately US$78 billion in net flows in Q1 2022.  

Europe also saw a significant reduction in new sustainable fund launches in Q1, partly attributed to weaker market sentiment brought on by the challenging macroeconomic backdrop, greenwashing accusations and the ever-evolving regulatory environment, the report said.  

In fact, the number of newly launched sustainable funds in Q1 2023 declined to a historical low of 53, down from 155 in the Q4 last year, the report noted. This compares to approximately 170 launches in Q1 2022.   

“The macro environment has had an impact on sustainable product development,” said Hortense Bioy, Global Director of Sustainability Research at Morningstar, noting that the number of new Article 8 and 9 funds launched over the previous quarter was significantly lower compared to the overall fund universe.  

“A clarification by the European Securities and Markets Authority (ESMA) last summer led many product manufacturers to downgrade Article 9 funds to Article 8 funds in the second part of the year, while waiting for further guidance on fund classification and how to interpret the definition of a ‘sustainable investment’ provided by Article 2 (17) of the EU’s SFDR,” the report added. 

Earlier this, month, the European Commission’s recent Q&A session on SFDR told asset managers that financial market participants carry the responsibility of defining sustainable investments.  

Prior to the EC declining to provide definition of sustainable investment under SFDR, asset managers had exercised growing caution in their compliance with disclosure requirements for Article 9-labelled funds, including resorting to increased reclassifications.   

Bioy pointed out that fund launch activity is typically higher in Q4 compared to Q1, with asset managers’ product development teams traditionally launching new products nearer the end of the calendar year.   

US sustainable outflows 

In the US, investors pulled US$ 5.2 billion from sustainable funds in Q1 2023, making it the third consecutive quarter of outflows in a year, the report said. In total, investors have withdrawn US$12.4 billion from sustainable funds over the past year. 

“In the US, besides the challenging market environment, another factor that could have contributed to the third quarterly outflow in a year is the political backlash against sustainable investing,” said Bioy. “While it’s hard to measure its impact on investor demand for ESG products, it is equally hard to ignore it.” 

Republican governors from at least 19 US states have pledged to resist ESG investing over antitrust, consumer protection, and discrimination concerns. Florida has ordered that state funds only consider financial returns when allocating capital, while Texas has opted to blacklist the asset manager BlackRock over its ‘woke’ boycott of the fossil fuel industry.  

The report noted that US-domiciled sustainable funds shed nearly US$5.2 billion, albeit mainly owing to a single fund, namely iShares ESG Aware MSCI USA ETF, which saw US$6.5 billion in outflows. US sustainable funds would have registered an inflow in Q1 2023 otherwise. 

Bioy noted that another driver for outflows in sustainable funds is that portfolio managers may see poor short-term performance prospects in ESG investments due to the macroeconomic backdrop, leading them to “withdraw or trim allocations” in ESG funds in favour of more “traditional quality exposure in preparation for a recession”.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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