Investors pull cash from ESG funds as performance lags

Global investors are turning their backs on sustainability-focused stock funds, as poor performance, scandals and attacks from US Republicans hit enthusiasm for a much-hyped sector that has pulled in trillions of dollars of assets.

Clients have withdrawn a net $40bn from environmental, social and governance (ESG) equity funds this year, according to research from Barclays, the first year that flows have trended negative. Redemptions, which include a record monthly net outflow of about $14bn in April, have been widespread across all main regions.

The outflows mark a significant reversal for a sector that investors have flocked to in recent years, attracted by the claim that such funds could help change the world for the better while also making as much — or even more — money as traditional stock portfolios.

Pierre-Yves Gauthier, head of strategy and co-founder at AlphaValue, a Paris-based independent research company, compared the sector to the tech bubble that burst in 2000. “ESG was a dotcom sort of hype 20 years later and now it has passed,” he said.

Many funds have been hit by the poor performance of sectors such as clean energy, while they have also missed out on strong returns from fossil fuel companies that they actively avoided.

Scandals such as one at German asset manager DWS — which agreed to pay $19mn to the US securities regulator in a greenwashing probe after being accused of making “materially misleading statements” — have also hit appetite for the sector.

Congressional Republicans 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 sector, which they say may violate antitrust laws.

BlackRock’s Larry Fink last year said he did not use the term ESG anymore “because it’s been entirely weaponised”.

Amid the backlash, US investors pulled $4.4bn from ESG equity funds in April, according to the Barclays research, which is based on data from fund tracker EPFR.

Assets in BlackRock’s largest US ESG fund have halved from $25bn at the peak in late 2021 to $12.8bn in May. Last year, the company dropped the ESG fund from its popular “60/40” model portfolio of stocks and bonds.

The largest US sustainable fund, Parnassus Core Equity, which has $28.4bn of assets, “has been one of the 10 biggest losers in terms of flows for two years straight”, Morningstar said in a report in May.

“US ESG flows are negative, and it is probably a testimony to what is happening in the context of the US with a very polarised and politicised debate around it which has frozen the behaviour on that front,” said Elodie Laugel, chief responsible investment officer at Amundi, which is the second-largest sustainable fund manager globally after BlackRock.

But the most recent data highlights that the pullback from ESG has reached Europe, the strategy’s traditional stronghold. ESG equity fund outflows in the region were $1.9bn in April.

Global investors’ appetite for ESG peaked at the end of 2021, just before Russia invaded Ukraine, leading to a surge in gas prices and fossil fuel stocks. Sharp interest rate rises by central banks in 2022 to combat inflation, meanwhile, punished high-growth technology companies, which are typically favoured by ESG funds over oil and gas businesses.

Over the past 12 months, global sustainable equity funds made an 11 per cent return, compared with 21 per cent for conventional stock funds, according to a May report from JPMorgan.

“Clearly, the fact that performance has not been good for these funds over the past two years . . . has discouraged some investors,” said Hortense Bioy, global director of sustainability research at Morningstar.

Suggesting that some ESG products might have failed to live up to their promise, Jamie Franco, global head of sustainable investments at asset manager TCW, said some funds launched in 2020-21 “probably went out a little too quickly [and] probably took advantage of some ESG marketing sentiment”.

But she added some investors continued to pursue ESG goals in separately managed accounts that were not necessarily captured by fund flow figures.

While withdrawals have hammered ESG equity funds, ESG bond funds have had 13 straight months of inflows through to April, according to Barclays. ESG bond funds have raked in $22bn this year.

Todd Cort, a professor at the Yale School of Management who specialises in sustainable investing, said that although the ESG label might increasingly fall out of use, underlying social and environmental challenges would remain.

“Behind the curtain, there will be substantially more effort by investors to understand environmental and social risks,” he said. “That will continue to grow, and I actually don’t care too much if we continue to call it ESG.”

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Letter in response to this article:

Sustainability — the trend that quietly delivers / From James Purcell, Former Deputy Chief Sustainability Officer, Credit Suisse, Kilchberg, Switzerland