The world’s ESG and sustainable funds paid back nearly 2.5 billion dollars to investors in the last quarter of 2023, according to calculations by Morningstar. This development marks the first instance of negative net flows for these funds, occurring amidst an increasingly challenging macroeconomic and geopolitical environment, coupled with a diminishing investor appetite for ESG investments.
Despite these headwinds, the sector still managed to attract substantial inflows over the year, with global sustainable funds amassing 63 billion in 2023, Morningstar data shows. This figure, though robust, represents a departure from the previously uninterrupted growth trajectory of ESG (Environmental, Social, and Governance) funds, reflecting changing investor sentiments and market dynamics.
In Europe, sustainable funds held up better than the broader market and garnered 3.3 billion dollars in net new money in the fourth quarter, thanks to passive funds, which collected 21.3 billion dollars. Actively managed sustainable funds, however, bled close to 18 billion dollars.
Quarterly Global Sustainable Fund Flows
“The disappointing reality is that active managers failed again to prevent redemptions in a corner of the market where it’s easier for them to prove their worth. By contrast, passive funds demonstrated consistent resilience,” commented Hortense Bioy, global director of sustainability research, Morningstar.
The global outlook for ESG fund flows in the last quarter might appear bleak, yet ESG funds in Europe – which constitutes the largest market by a considerable margin – consistently outperformed the broader fund universe, Morningstar said. Moreover, the value of global ESG fund assets continued to ascend.
Over the full year, European sustainable funds garnered 76 billion dollars. By comparison, European conventional funds suffered annual outflows of 50 billion dollars.
European Sustainable Fund Flows (USD Billion)
A few factors contributed to the lower inflows into sustainable funds in Europe last year: the challenging macroenvironment, including high interest rates, inflation, and fears of recession in some parts of the world. Among other implications, Morningstar noted that this has led investors to favour government bonds, an area that has limited ESG products because ESG integration remains challenging in that corner of the fixed-income market—in fact, it is not feasible in the case of single-country government funds like U.S Treasuries or U.K. gilts.
Also, the report said, it is fair to assume that some investors took a more cautious approach to ESG investing last year in the wake of the underperformance of ESG and sustainable strategies in 2022. “While the technology sector rebounded in 2023, other popular sectors in sustainable strategies continued to underperform,” it said.
Renewable energy companies, for example, have been particularly affected by soaring financing costs, materials inflation, and supply chain disruptions, among other issues. Additional factors weighing on investor demand for sustainable funds include greenwashing concerns and the ever-evolving regulatory environment. The wave of fund reclassifications to Article 8 from 9 in late 2022, 3 and other issues related to the implementation of SFDR, have caused confusion among investors and other market participants.
U.S. demand continued to fade
In the U.S. investors pulled a record five billion dollars from sustainable funds in the last quarter, for a total of 13 billion over 2023. The fourth-quarter outflows were nearly double the ones that Morningstar reported for the third quarter. It said that the latest data marked the fifth-consecutive quarter where investor appetite for U.S. sustainable funds was weaker than for their conventional counterparts.
U.S. Fund Flows: Sustainable Vs. All U.S. Funds (USD Billion)
Supported by stock and bond price appreciation, global sustainable fund assets rose by 8% over the last quarter to almost three trillion dollars at the end of December.
Product development picked up, Morningstar noted. More than 120 new sustainable funds hit the shelves globally in the fourth quarter.