Global investors are turning away from sustainable-oriented stock funds as poor performance, scandals and attacks from US Republicans increase enthusiasm for a much-hyped sector that has raked in trillions of dollars in assets.
According to research from Barclays, clients have withdrawn a net $40 billion from environmental, social and governance (ESG) equity funds this year. This was the first year that capital flows were negative. Redemptions, including record monthly net outflows of around $14 billion in April, are widespread across all major regions.
The outflows mark a significant turnaround for a sector that investors have flocked to in recent years, drawn by the claim that such funds can help change the world for the better while making as much – or even more – money as traditional stock portfolios.
Pierre-Yves Gauthier, chief strategy officer and co-founder of AlphaValue, a Paris-based independent research firm, compared the sector to the technology bubble that burst in 2000. “ESG was a kind of dot-com hype 20 years later and now it’s over,” he said.
Many funds have been hit by the poor performance of sectors like clean energy, while also missing out on strong returns from fossil fuel companies that they have actively avoided.
Scandals such as the one at German asset manager DWS – which agreed to pay $19 million to the US securities regulator in a greenwashing investigation after being accused of making “materially misleading statements” – have also fueled interest in the sector.
Republicans in Congress have attacked ESG investing as “radical partisan activism masquerading as responsible corporate governance.” The Republican-controlled House of Representatives has subpoenaed BlackRock and rival State Street as part of an investigation into the industry, which they say could violate antitrust laws.
BlackRock’s Larry Fink said last year that he was no longer using the term ESG “because it has been completely weaponized.”
Amid the backlash, US investors pulled $4.4 billion from ESG equity funds in April, according to the Barclays study, which is based on data from fund tracker EPFR.
Assets in BlackRock’s largest US ESG fund have halved from $25 billion at its peak in late 2021 to $12.8 billion in May. Last year, the company removed the ESG fund from its popular ’60/40′ model portfolio of stocks and bonds.
The largest U.S. sustainable fund, Parnassus Core Equity, which has $28.4 billion in assets, “has been one of the top 10 losers in terms of capital flows for two years in a row,” Morningstar said in a report in May.
“US ESG flows are negative, and it is probably a testimony to what is happening in the US context, with a highly polarized and politicized debate around it, which has frozen behavior on that front,” said Elodie Laugel, Chief Responsible Investment Officer. at Amundi, the world’s largest sustainable fund manager after BlackRock.
But the latest data highlights that ESG’s retreat has reached Europe, the strategy’s traditional stronghold. Outflows from ESG equity funds in the region amounted to $1.9 billion in April.
Global investor interest in ESG peaked in late 2021, just before Russia invaded Ukraine, leading to a surge in gas prices and fossil fuel stocks. Sharp interest rate hikes by central banks in 2022 to combat inflation, meanwhile, punished fast-growing tech companies, which are typically favored by ESG funds over oil and gas companies.
According to a May report from JPMorgan, global sustainable equity funds returned 11 percent over the past 12 months, compared to 21 percent for conventional equity funds.
“It is clear that the performance of these funds has not been good over the past two years. . . has discouraged some investors,” said Hortense Bioy, Global Director of Sustainability Research at Morningstar.
Jamie Franco, global head of sustainable investments at asset manager TCW, suggested some ESG products may not have lived up to their promise, saying some funds launched in 2020-2021 “probably exited the market a little too quickly”. [and] likely benefited from ESG marketing sentiment.”
But she added that some investors continued to pursue ESG goals in separately managed accounts that were not necessarily reflected in fund flow figures.
While withdrawals have hit ESG equity funds hard, ESG bond funds have had 13 consecutive months of inflows through April, Barclays said. ESG bond funds have raised $22 billion this year.
Todd Cort, a professor at the Yale School of Management who specializes in sustainable investing, said that while the ESG label could increasingly fall out of use, the underlying social and environmental challenges would remain.
“Behind the scenes, investors will put significantly more effort into understanding environmental and social risks,” he said. “That will continue to grow, and it doesn’t really matter to me if we continue to call it ESG.”