Environmental, social, and governance-focused investment was all the rage a couple of years ago. The impulse to signal an environmentally or socially responsible reputation was so strong that ESG investment funds saw massive influxes of fresh assets.
Now, ESG funds are shutting down or dropping the “sustainable” part from their names. Their performance is leaving a lot to be desired, and investors are fleeing. It is a moment of truth for the nascent market niche, and the truth hurts.
Reuters reported this week that funds classified as sustainable saw net new inflows of $68 billion over the first 11 months of the year, which compares with $158 billion last year, per data from LSEG Lipper, the fund performance data provider owned by Reuters’ parent.
That’s quite a drop, but compared to 2021, the 2023 figure looks even worse: in 2021, net new inflows into ESG funds totaled $558 billion, LSEG Lipper data shows.
“What happened?” is the question that should now be asked.
What happened was a number of things. First, oil prices tanked in 2020 because of the lockdowns. They stayed tanked in 2021, leading many investors to flee the sector and seek diversification. Second, greenwashing reared its ugly head. Third, the transition leaning on these funds stuttered amid soaring cost inflation.
In April 2020, the price of U.S. crude oil slipped below $0 for the first time ever. The event, though short-lived, highlighted the impact that pandemic lockdowns were having on global energy markets-and perhaps more importantly, energy demand.
Investors quit oil and gas and sought new opportunities. ESG funds were being actively promoted as both profitable and moral-a win-win situation many could not resist, not least because of the firm government hand behind the sustainable future these funds advertised as working to build.
Then, the pandemic lockdowns ended. People started leaving their houses again. Energy demand rose. Oil demand rose. So did oil prices. Inflation pushed the costs of all forms of energy higher. And reports began to emerge that not everything that calls itself sustainable is actually sustainable.
ESG funds began to close: this year alone, more than two dozen such funds were closed, per Bloomberg. Others are seeing investor outflows because of the absence of clear ESG targets. The “sustainable” designation is no longer enough. Some funds are dropping the label “sustainable” from their names altogether because it is no longer bringing in investors.
Regulators are tightening the rules about which funds actually have the right to call themselves sustainable. The SEC last year launched an investigation into Goldman Sachs’ ESG funds. Tennessee is currently suing BlackRock over its ESG strategies, which, the state says, violate consumer protection laws by overstating “the extent to which ESG considerations can affect companies’ financial performance and outlook.”
That lawsuit is an instance of another problem for ESG investing: a Republican state backlash against the trend that saw some states, such as Texas, threaten to pull out their own money from asset managers that, according to them, discriminate against the oil and gas industry.
Meanwhile, to make matters worse for ESG fund managers, oil prices have livened up considerably. The year 2022 delivered record profits for Big Oil. Investors previously eager to make some money from being environmentally, socially, and governance responsible returned to the land of emissions. Regulators pushed harder against greenwashing.
ESG funds did outperform the broader market despite changing investor sentiment. But it wasn’t because sustainable business was making a lot of money. It was because Big Tech was making a lot of money, and ESG funds tend to have a heavy exposure to Big Tech.
Big Tech majors are indeed the biggest fans of sustainability with their wind and solar PPAs and their carbon offsets. These also fell from grace this year as it emerged that carbon offset projects were not, for the most part, offsetting anything.
All in all, this year investor behavior and attitude towards ESG funds has reflected the deepening troubles of transition-related industries. Wind power project costs soared so high that some projects became unviable. For others, project developers asked for and received commitments for higher electricity prices once the projects became operational.
Solar power did better, but demand is on the wane there, too, not least about those same higher costs and the EU’s and the U.S.’ latest push against China. Most recently, the crisis in the Red Sea that diverted most traffic between Asia and Europe will also add to the cost of equipment coming from China.
EV makers had a bad year as well, rising manufacturing plans as demand failed to live up to expectations consistently and despite government efforts to incentivize it via subsidies. Reports about EVs catching fire multiplied, and so did complaints about the cars’ performance.
Then, this week, Reuters published a detailed investigation into Tesla, revealing tens of thousands of grave mechanical failures that the company knew about for years but blamed on the drivers. Deutsche Bank’s chief investment officer for ESG said oil and gas stocks should be added to ESG funds because investors wanted to invest in oil and gas.
Demand for ESG investing will probably remain less enthusiastic than two years ago next year as well. Regulators are still keeping an eye on the segment, ready to start regulating harder at the drop of a feather. Oil and gas are on the climb again. Based on 2024 demand and supply forecasts, they may continue climbing for some time. Governments will need to work harder to keep investors green.
By Irina Slav for Oilprice.com
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