Are investors hitting the ‘pause' button on sustainable investing?

Business Times

18-05-2025

[SINGAPORE] Sustainable investing was all the rage some years ago, but its shine appears to be fading. What would it take to revive investor interest?
Morningstar's latest fund flows data for global sustainable funds in the first quarter found 'record-high' outflows mainly in the US – which isn't a surprise – but also in Europe, albeit to a more modest degree.
This is happening at a time when global temperatures are rising, and energy transition and climate commitments are under threat even as war has intensified carbon emissions.
What factors are driving investors' change of heart? One is US president Trump's anti-ESG and anti-DEI (diversity, equity, inclusion) rhetoric and policies, which may have caused negative investor sentiment to deepen. Relatively poorer returns from sustainable funds compared to conventional funds may also exacerbate dissatisfaction.
The US administration's anti-ESG policies are also causing asset managers to turn cautious on new products for fear of stepping into a legal minefield. Managers also grapple with an evolving regulatory backdrop, where new rules focusing on fund names and marketing are taking effect. Over the past couple of years, managers fined for greenwashing included DWS in Europe and Invesco and Goldman Sachs in the US.
Morningstar data for the first quarter of 2025 shows redemptions of US$8.6 billion, with the US accounting for 70 per cent or US$6.1 billion. The US sustainable funds market has so far seen 10 consecutive quarters of net outflows. Europe's outflows at US$1.2 billion were more modest, but it was the first net outflow since Morningstar began to track sustainable investment funds in 2018.
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Morningstar said an increasingly complex geopolitical environment has 'deprioritised sustainability concerns in Europe, including climate goals''.
Trump's anti-ESG policies have had a ripple effect. 'For some European investors, the rollback in ESG commitments by US firms has created hesitation, undermining the sense of global alignment on climate and sustainability goals. This hesitation is further compounded by an evolving European regulatory agenda and ESG fund landscape, while persistent performance concerns – particularly in already challenged sectors such as clean energy – continue to weigh on investor appetite for sustainability strategies.'
The sustainable funds universe comprising open-ended funds and exchange traded funds has US$3.16 trillion in assets as at end-March, just a tad lower than US$3.18 trillion at the end of Q1 2024. Europe's share is 84 per cent, and the US 10 per cent share.
Disappointing performance
Returns from funds with a sustainable bent – which include screening for ESG factors and/or exposure to sustainable development goals – have underperformed since around 2022. Elston Consulting notes that the 'golden era' of ESG investing appeared to have been the Covid era, when ESG-focused world indexes outperformed and the funds saw record inflows.
But higher inflation, which now looks set to be sticky, and elevated geopolitical tensions have reversed that. Elston said ESG-focused funds do not hold fossil fuel companies and had less exposure to sectors seen to provide a degree of inflation protection, such as commodities and energy. Heightened geopolitical tensions such as the ongoing Ukraine war also boosted the defence sector, which is excluded from sustainable funds.
'While pre-2022 some have argued for an ESG premium over the long run (good companies should be well rewarded via a lower risk premium), since 2022 the hard reality of ESG relative underperformance compared to traditional equities is a reminder that any such premium is indeed 'long run', and in the meantime, short- and medium-term performance differentials matter too,' the firm wrote.
The MSCI World Selection Index, which uses ESG criteria, has underperformed the conventional MSCI World Index for various periods up to 10 years. Year to end-April, the World Selection index lost 2.54 per cent against minus 0.77 per cent in the MSCI World. Over three years, the annualised return was 10.62 per cent against 11.6 per cent, respectively.
What's in a name?
Fund launches have tamped down significantly in recent quarters, Morningstar said, reflecting the 'normalisation' of product development activity after high growth in the years 2020 to 2022. There were only 54 new funds globally in the first quarter, compared to 105 in the previous quarter. 'Asset managers have become more cautious in their development of new ESG and sustainable strategies because of greenwashing accusations and uncertainty around regulations.'
The European Union's Sustainable Finance Disclosure Regulation is still under review. Managers are also assessing the impact of the European Securities and Market Authority fund-naming guidelines.
In terms of names, Morningstar notes saw a surge in activity from 2019 to 2022 as managers added ESG-related terms to fund names. But this has since given way to the new trend where ESG terms are dropped or changed. In the first quarter of 2025, about 335 funds with ESG terms in their names were rebranded, including 206 which changed an ESG term for another; 116 funds dropped ESG terms in the fund names altogether.
Morningstar estimates that in total more than 640 European funds with ESG-related terms in their names have rebranded. The most popular new descriptor is 'screened'. New words also emerged to replace contentious terms such as selected, committed, tilt and optimsed.
MSCI itself has removed the terms ESG and impact from five of its indices in response to tightening greenwashing regulations.
Going forward
The way forward for investors is far from simple, and hence, it may well make sense for some to hit the pause button on allocations into sustainable funds. Various surveys continue to show a desire to invest sustainably among younger investors, but there is arguably a greater need to more careful define their objectives and expectations of returns.
In a sobering paper, the Cambridge Institute for Sustainability Leadership said the financing gap for climate and sustainability targets remains as pressing as it has ever been. It notes there is the opportunity to unlock US$10 trillion of opportunities in investment, lending or insurance.
'But, after decades of aspiring to fulfil sustainability ambitions, the current financial system is still not incentivised to consider sustainability in financial decision-making, and therefore not set up to support this transition,' the report's authors Neena Seega and Eliot Whittington wrote.
'There are no capital charges on unsustainable activities because the current capital framework is not intended to protect the broader economy from wider climate and nature risks. As a result, there is no incentive to exit stranded assets if they are rent bearing in the short term. And because there is a market failure to price the true cost of economic activity, climate-negative and nature-degrading activities make more money than sustainable activities, directing private capital towards anticipated profits.'
RepRisk, which provides reputational risk data, finds an overall decrease in greenwashing cases in 2024 for the first time in six years, but high-risk cases of greenwashing surged by over 30 per cent. Severity is defined in terms of the consequences of the risk incident; the extent of its impact; and the degree to which the incident was intentional and systematic.