ESG fund managers are facing one of the toughest moments in the strategy’s history, as investment clients pull record amounts of money.
Funds complying with the European Union’s strictest ESG standards suffered record outflows last quarter, according to fresh data from Morningstar. That follows an analysis by the market researcher showing ESG fund managers in the US just had their worst year ever. At the same time, a record number of funds has now scrapped ESG and related terms from their names, Morningstar reported.
“The story for equity funds in ESG hasn’t been great,” Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics, said recently. A lot of ESG funds offering “clean energy, clean-tech and climate solutions haven’t done well in the context of high interest rates”. Even after the decline in funds dedicated to sustainable strategies, ESG still sits on US$3.2 trillion of total fund assets, globally, Morningstar estimates.
Record redemptions are the latest piece of bad news for proponents of ESG (environmental, social and governance), as investors turn away from a strategy that’s been plagued by lacklustre returns, regulatory fatigue and political backlash. The development is being used as an opportunity by some companies and lawmakers in Europe to call time on ESG rulemaking, especially in the light of US President Donald Trump’s embrace of deregulation in the world’s largest economy.
In the US, ESG fund managers suffered almost US$20 billion of withdrawals last year, a Morningstar report published earlier this month showed.
Europe, which accounts for more than 80 per cent of the world’s ESG fund assets, has already acknowledged that it needs to recalibrate a whole range of ESG regulations as the complexities of introducing such an ambitious framework within a relatively short period of time become clear.
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Rules for ESG fund disclosures in Europe are currently being overhauled, after investors and even national regulators criticised the existing framework, known as the Sustainable Finance Disclosure Regulation.
Meanwhile, Germany and France are pressing the European Commission to scale back planned ESG reporting requirements for companies across all industries.
In a recent interview, the EU’s new commissioner for financial services, Maria Luis Albuquerque, said the bloc remains committed to its landmark Green Deal. However, details of the regulatory and legislative roll-out probably need to be tweaked, she said.
“We may need to adjust the pace and especially eliminate some overlaps and inconsistencies, which happened because we were putting forward a lot of legislation in a short period of time,” she said. “We understand the concerns, we understand the burden or – as I’ve heard it – the fatigue, and we need to address that.”
Albuquerque cautioned against anticipating deregulation from the EU.
Instead, “it’s adjusting the pace” while “maintaining the anchor”, she said. “Because I do believe, and I think that most people also believe that sustainability is a medium to long-term competitiveness advantage.”
Investors who focused on the greenest of assets in recent years have yet to see those bets pay off. Since the beginning of 2022, as pandemic-era emergency measures including interest rates at crisis lows started to fade, the S&P Global Clean Energy Index has lost roughly half its value. In the same period, the S&P 500 Index rose almost 30 per cent.
Tan Jenn-Hui, chief sustainability officer at Fidelity International, says that despite the headwinds, a lot of asset managers are still working hard to implement the existing EU’s existing ESG regulations.
“What we and everyone else is doing is getting on with the business of complying with these regulations, making sure that our businesses are future-fit, and if there are changes, then we have to be able to adapt to these changes,” he said. “And we, like many others, are preparing for a range of different outcomes on how those changes might land or might not land.”
Tan also said it’s important to keep in mind how monumental the current regulatory shift is.
“I don’t think we should underestimate how quickly this space has evolved, how much we’ve achieved in the last three, four years,” he said.
Morningstar’s latest analysis shows that redemptions from European funds registered as Article 9 – the name given to the EU’s strictest ESG category – reached 7.3 billion euros (S$10.3 billion) in the final three months of 2024. That’s more than double the level of outflows seen in the third quarter and marks the fifth straight quarter of withdrawals.
Equity funds in Europe registered as Article 9 were the hardest hit, with withdrawals of 6.4 billion euros, Morningstar said. A separate category known as Article 8, which has been criticised for being too broad an ESG designation to be meaningful, saw inflows of 52 billion euros mostly due to rising demand for fixed-income funds, Morningstar said. Funds registered as Article 6, a non-ESG category, saw 85.4 billion euros of inflows. Net new investments into both Article 8 and Article 6 funds have risen in recent quarters.
And even though record numbers of funds just dropped ESG terms from their names, it’s likely that trend will pick up in coming months, as asset managers try to adapt to stricter rules due to be enforced by the European Securities and Markets Authority in May.
“Overall, we anticipate that between 30 and 50 per cent of in-scope funds will change names, representing between 1,200 and 2,200 funds,” Morningstar said.
Investors also need to brace for a world in which SFDR fund disclosure categories may be replaced – or supplemented – by new labels intended to give retail clients a better sense of what they’re buying.
Investors should be able to choose between strategies that broadly target sustainability, the net-zero transition or an ESG category defined by its exclusion of a number of harmful activities, the Platform on Sustainable Finance, which advises the EU’s executive arm, said in December.
Morningstar’s analysis shows that Article 9 funds hit by the biggest client redemptions last quarter were the BlackRock Sustainable Energy Fund, which lost 576 million euros of outflows as its value dropped 9 per cent in 2024.
The Nordea 1 – Global Climate and Environment Fund saw 520 million euros of withdrawals, despite gaining 14 per cent last year. And the Pictet – Global Environmental Opportunities fund, which gained 10 per cent in 2024, saw 498 million euros of outflows, the data show.
Last year “was a period of shifting narratives, with the US election, a surging dollar, stubborn inflation, and a more cautious interest-rate-cutting stance”, Morningstar said in its report. BLOOMBERG
