Many newspapers now talk of the declining demand for ESG funds (defined as funds with ESG or sustainability-related terms in their name). 

So is investment into ESG funds really falling? Yes - but not for the reasons you may think.

A key reason behind this is that the actual number of 'ESG funds' on the market has decreased, due to the regulatory clampdown on greenwashing.

The bar on greenwashing is rising

In most jurisdictions, financial regulators are increasingly determined that the sustainability characteristics of any fund marketed under an ESG banner are robust, transparent and quantifiable. Unsurprisingly, this has made the marketing teams and legal compliance units of most asset managers very nervous.

As an example, Blackrock has just dropped sustainability-related terms from 56 funds, representing ~£40bn of managed assets. Blackrock has admitted there will be no change to the actual investment strategies of these funds - but these 56 funds do not meet the new EU criteria for sustainability-related fund names.

So are investors leaving the funds that retain ESG nomenclature?

Even with this name-change trend, inflows into ESG-named funds are still rising. Global inflows in Q4 2024, using Morningstar data, were $16.0bn. This was up on the Q3 2024 inflow of $9.4bn.

The US however, is seeing ESG fund outflows. This is all because of the socio-political backlash against ESG, right?

Wrong. The US has seen ESG fund outflows for every quarter since Q2 2022. The Biden administration was still driving a sustainability agenda then, but then 2 very important things happened around Q2 2022:

🇷🇺 Russia invaded Ukraine in February, causing a surge in oil & gas prices 

📈 US interest rates started rising in April

A majority of US ESG funds share 2 characteristics: they have no oil & gas exposure, and they are long renewable energy generation.

Renewable energy generators are what investors call a ‘long duration asset’; meaning the bulk of the net cash flow comes far out in time, and therefore the asset’s present value will be particularly hurt by rising interest rates.

So, both the macroeconomic events of Q2 2022 badly impacted ESG funds, and the ongoing impacts led to a widespread loss of confidence in 'ESG as an investment'.

Will this continue to be the case?

At this point, there are too many unknown variables to make a definitive judgment.

For example, if oil prices started a reversion to where they started this decade ($20 per barrel), the landscape for investment in ESG funds might improve sharply once again.

Global demand for sustainable funds is not going away. And once we see a period of stronger investment performance, convincing wary investors that sustainability does not reduce returns, we will see a boost to demand.

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𝗧𝗵𝗶𝘀 𝗮𝗿𝘁𝗶𝗰𝗹𝗲 𝘄𝗮𝘀 𝘄𝗿𝗶𝘁𝘁𝗲𝗻 𝗯𝘆 𝗜𝗻𝘁𝗲𝗴𝗿𝘂𝗺 𝗘𝗦𝗚 𝗙𝗼𝘂𝗻𝗱𝗲𝗿 𝗮𝗻𝗱 𝗖𝗘𝗢 𝗦𝗵𝗮𝗶 𝗛𝗶𝗹𝗹.

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