Difficult year for ESG funds despite robust inflows

Based on FT analysis

Despite the growing popularity of environmental, social and governance (ESG) funds, the past year has been a challenging one for the industry. In the third quarter of 2022, sustainable funds saw USD 22.5 billion in net new global investments, according to Morningstar. While this was lower than the USD 33.9 billion in inflows seen in the second quarter, it was a strong showing considering the fact that the market as a whole saw net outflows of USD 198 billion during Q3. However, the ESG sector faced criticism from both supporters and opponents, as well as regulatory scrutiny over concerns about “greenwashing”.

In November, Goldman Sachs agreed to pay a USD 4 million penalty to the US Securities and Exchange Commission to settle charges related to failures in its ESG research policies and procedures. German police also raided the offices of fund manager DWS in connection with claims by a whistleblower relating to flaws in the company’s ESG strategy, leading to speculation about whether other asset managers may face similar action in the future. The resulting negative publicity has made it difficult for the industry to maintain its reputation as a moral leader.

A study by MSCI found that the largest asset managers have the highest carbon footprint per USD 1 million invested when considering scope 1 and 2 emissions directly produced by companies or as a result of their activities. ESG funds have also faced criticism in the US for being associated with “woke capitalism”. By October, ten states had adopted anti-ESG regulations aimed at restricting public pensions and government entities from doing business with entities that may be “boycotting” industries based on ESG criteria, according to law firm Morgan Lewis. Vanguard also announced in December that it would withdraw from the Net Zero Asset Managers initiative, which aims for net-zero carbon emissions by 2050.

Despite these challenges, analysts predict that demand for ESG products will continue to grow, with the BlackRock Investment Institute forecasting an acceleration in the global transition to net-zero carbon emissions. However, investors seeking clarity through tighter regulation may have to wait, as EU regulators grapple with the complexity and confusion following the first set of rules on sustainable finance. The confusion has in turn led to fund downgrades affecting tens of billions of dollars in client money. Hortense Bioy, Global Director of Sustainability Research at Morningstar, noted that the global ESG ecosystem is made even more complex by different regulatory approaches in different jurisdictions.

Despite the difficulties, some experts remain optimistic about the future of ESG investing. Tom Monaghan, co-head of Global Sustainable Research at Amundi, believes that the industry is at a “tipping point” and that increased demand for ESG products will lead to more investment opportunities and improved performance. Monaghan also predicts that the industry will see more collaboration between asset managers and companies in order to drive sustainability initiatives.

Overall, while the past year has been a difficult one for ESG funds, strong inflows indicate that demand for these products is still growing. While regulatory challenges and negative publicity may continue to plague the industry, experts remain optimistic about the future and believe that the adoption of sustainable investing practices will only continue to grow.