ESG faces tough times amid higher rates and investor exodus

A boom in the use of environmental, social and governance (ESG) factors in the financial world has fed scepticism that the approach is nothing more than a marketing gimmick, fuelling a backlash and regulatory crackdown.
And for the first time ever, ESG funds saw net global outflows amid a major exodus by US investors from such strategies.
US fund clients withdrew a net $5.1bn in the final three months of 2023, according to a fresh analysis by Morningstar.
Combined with $1.2bn in outflows in Japan, that was too severe a retreat for Europe’s $3.3bn of net inflows to bolster the global market.
In all, the global sustainable fund market experienced net redemptions of $2.5bn in the fourth quarter, marking an historic low point for the industry.
ESG is part of a wider strategy known as sustainable investing. Broadly, the goals are to achieve societal impact, align with personal values or manage risks, proponents say.
But US scepticism toward ESG follows years of attacks by Republicans who accuse the strategy of being “woke” and anti-capitalist.
The retreat from ESG also lies in the failure of actively managed strategies to draw in clients, according to Morningstar analysis.
Even in Europe, fund flows were buoyed by $21.3bn of allocations into passive strategies, while actively managed funds lost almost $18bn.
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,” according Hortense Bioy, global director of sustainability research at Morningstar. “By contrast, passive funds demonstrated consistent resilience.”
In the US, meanwhile, the pace of outflows was almost double the $2.7bn registered in the third quarter.
Much of that development should be seen against the context of persistently high interest rates, fears of a recession as well as anxiety relating to the spread of war. Even so, redemptions last quarter left a bigger dent in ESG funds than in conventional portfolios, the researcher’s data showed.
Net outflows represented a decline of 0.1% relative to total global sustainable fund assets. For the broader fund universe, net outflows were equivalent to 0.05% of the total, Morningstar said.
Europe’s banks are asking investors not to pay too much attention to a new green metric due to be published in in the coming weeks, as early estimates show the industry woefully behind where it needs to be.
In the US, ESG efforts have been derided by some state officials, claiming they prioritise liberal values at the expense of financial returns.
Some supporters think the term ESG has become so broad as to lose much of its meaning. Many point to the prevalence of greenwashing, which is when companies exaggerate the environmental benefits of their actions.
Other criticisms focus on the way fund managers rank companies by how they’re performing on ESG factors.
At the same time, ESG risks have become all the more prominent as extreme weather events and worker strikes have hurt automakers, insurers and travel companies.
Last year was the planet’s hottest on record (going back to 1850) by a substantial margin and likely the world’s warmest in the last 100,000 years, the European Union’s Copernicus Climate Change Service (C3S) has said.
Just as the world saw record land and sea temperatures in 2023, so some research models have for long suggested up to a quarter of global GDP could be lost if no action is taken to reduce carbon dioxide emissions.
An industry shakeout is seen underway amid calls for tougher regulations to stamp out the false claims by fund managers.