Sustainable funds in the US shed more than US$13bn in 2023, marking the first year of net outflows in more than a decade as the ongoing political backlash and high interest rates continue to subdue appetite for ESG-focused investments.
US sustainable funds shrank by 4.6% last year, whereas their conventional peers grew by 0.3%, according to Morningstar data.
Despite the outflows, the value of assets in sustainable funds increased and passed US$300bn, which points to longer-term growth, the data provider said.
BlackRock remains the largest firm in terms of sustainable fund assets, but saw the biggest annual net outflow in 2023. The firm’s largest sustainable fund – iShares ESG Aware MSCI USA ETF ESGU – lost US$9.3bn, more than any other sustainable fund.
Large US asset managers – including BlackRock, State Street and Vanguard – are under pressure to roll back ESG investing practices amid continued attacks by some Republican politicians. Their support for ESG shareholder resolutions has also dropped significantly in the past two years.
More than 20 states have introduced legislation restricting the use of environmental, social, and governance factors when making investment decisions, according to law firm Ropes & Gray.
Mixed returns
Sustainable equity funds were worse hit than their fixed-income counterparts with US$13.8bn of net outflows last year, as high interest rates dented demand for capital-intensive renewable energy projects and hurt the valuation of clean tech companies.
On average, sustainable equity funds' performance trailed their benchmarks by 3.5 percentage points. More than half the funds’ performance lagged behind their respective benchmarks last year.
Sustainable bond funds slightly outperformed the benchmark in 2023 and saw US$1.4bn of inflows as investors looked to lock in attractive yields.
In general, sustainable funds have held up better over the medium term. About 60% had above-average returns in the trailing five-year period, although many did not benefit from the surge in energy prices following Russia’s invasion of Ukraine in 2022 due to fossil fuel exclusion policies.
The underperformance of sustainable investments in 2023 could also be attributed to index exclusion of certain big tech companies such as Meta and Alphabet, which led the market rally, a separate Morningstar report found.
For instance, Meta was automatically excluded from some ESG indexes due to privacy and data security concerns, said Robert Edwards, director of product management for EMEA and ESG Indexes at Morningstar.
Slower growth
Sustainable fund launches slowed amid soft investor demand. Only 66 new funds came to market last year, down from 103 in 2022 and 116 in 2021. Nearly two-thirds of product launches were actively managed equity funds.
Fund closures and departures also reached an all-time high as 45 sustainable funds closed last year, while eight funds dropped their ESG mandates.
Although demand for US sustainable funds has moderated in the past two years, Morningstar said the pace of outflows and product closures is "nowhere close" to the growth that the space has seen over a longer timeframe.
The 12% growth in asset values in sustainable funds to US$323bn last year is nearly six times larger than a decade earlier, for example.
The level of outflows from sustainable funds is expected to moderate in 2024, although strong inflows are unlikely, said Alyssa Stankiewicz, associate director of sustainability research at Morningstar.
The outcome of the US Presidential election in November and upcoming climate regulation, will have significant impact on fund flows, Stankiewicz noted.
“It's a major factor in investor confidence in the ESG space and will direct some institutional assets,” she said.