Morningstar calls for clarity as US investors pull US$5 billion against electoral backdrop, while Europe registers slight inflows.
Global sustainable funds faced outflows of nearly US$2.5 billion in Q4 according to data from Morningstar, the first case of negative net quarterly flows for the sector, largely driven by US trends.
Last year, global sustainable funds gathered US$63 billion, less than half of the US$161 billion in 2022. Europe and the US account for a combined 95% of global sustainable fund assets, with 84% in the former and 11% in the latter.
The net outflows in Q4 were largely driven by US investors, who pulled a record US$5 billion from US sustainable funds in the quarter. This took the total net outflows for the year in the region to US$13 billion.
“I suspect that the sustainable investing landscape in the US is either maturing or at least reaching a temporary plateau”, Alyssa Stankiewicz, Associate Director of Sustainability Research at Morningstar, told ESG Investor. “The industry needs to become clearer about what the different terms – including ESG, sustainability and impact – mean and how they affect portfolio construction to regain confidence among US investors.”
In December, Tennessee Attorney General Jonathan Skrmetti filed a suit against BlackRock for allegedly misleading investors about the role of ESG considerations in investment decisions.
The US Securities and Exchange Commission (SEC) adopted a new ‘Names Rule’ last September to improve accuracy and reliability of the naming of investment funds.
Morningstar’s sustainable fund universe encompasses funds that “claim to focus on sustainability; impact; or ESG factors”.
In Q4 2022, sustainable fund flows attracted US$37 billion and assets reached US$2.5 trillion globally.
While Stankiewicz acknowledged the majority of last year’s outflows came from non-institutional share classes, she noted the demand for sustainable funds has fallen from their 2020-2021 peak and flows were “nearly flat” last year.
Morningstar suggested the causes behind the US outflows included greenwashing concerns, lacklustre returns on investment, the absence of clear regulation, as well as the continued and increasing politicisation of ESG and sustainable investing.
“Some institutional investors – in Texas and New Hampshire for example – have encountered increasing political pressure to move away from ESG-focused and ESG-integrated funds which we expect would contribute to weaker demand,” said Stankiewicz. “2024 is a national election year in the US, so I anticipate the political scrutiny of sustainable investing to continue.”
The Morningstar report highlighted this was the fifth consecutive quarter where investor appetite for US sustainable funds was “weaker than for their conventional counterparts”.
The final quarter of 2023 marked a minimal rebound from the three-year low set for the launch and repurposing of US sustainable funds in Q3. Three new sustainable funds in that three-month period were followed by seven in Q4, down from 27 in Q2.
A total of 67 new sustainable fund launched last year in the US, a sharp fall from more than 100 in both 2021 and 2022.
“To me, this dramatic change signifies that we are at an inflection point,” said Stankiewicz. “The next year or two should be very interesting on the regulatory front and for investor expectations.”
Europe “holds up”
While European sustainable funds only attracted US$3.3 billion of net new money in Q4, down from the revised US$11.8 billion of inflows in Q3. Europe and Australia/New Zealand were the only regions to see inflows of over half a billion.
Overall last year, European sustainable funds garnered US$76 billion, while conventional funds suffered annual outflows of US$50 billion.
“The global ESG fund flow picture in the last quarter may look bleak but ESG funds in Europe – by far the largest market – continued to hold up better than the rest of the fund universe,” said Hortense Bioy, Global Director of Sustainability Research at Morningstar. “Global ESG fund assets kept rising too.”
However, demand for Article 8 funds under Sustainable Finance Disclosure Regulation dipped, registering a record €26.7 billion (US$29 billion) of outflows in Q4, while Article 9 funds suffered first-ever quarterly outflows of €4.7 billion.
Article 8 funds promote “environmental and/or social characteristics”, while Article 9 refers to products that have a sustainable investment objective; all holdings within a fund must be sustainable investments that meet the standard of “do no significant harm”.
According to Morningstar, this was driven by “persistent macroeconomic pressures and waning investor appetite for ESG and sustainable products”.
The firm also pointed out that active sustainable funds suffered the strongest outflows in Europe in Q4 while passive funds maintained “positive momentum”. Article 6 funds experienced net inflows of €15.7 billion over the quarter.
Overall across the quarter, sustainable funds “fared better” than the European conventional funds, which bled US$25.4 billion in the past three months, Morningstar noted.
“In past reports, we have shown that flows into European sustainable funds have been resilient, compared with the rest of the world and especially the US,” said Stankiewicz.