The real story with ESG fund flows

Written By Greg Lessard

More money is flowing out of sustainable funds than into them. Should ESG investors panic?


MAIN TAKEAWAY

ESG funds are seeing net outflows recently, but that doesn’t mean ESG investing is dead.

KEY TALKING POINTS

  • A single asset manager’s decision to remove an ESG fund from their models heavily skewed ESG fund flows in early 2023.

  • 12% of all managed assets follow a dedicated ESG investment mandate.

  • Overall ESG fund outflows are relatively small.

  • Recent index fund ESG ETF flows have been positive.

DEEPER DIVE

By the end of the first quarter of 2023, sustainable funds saw $5.2 billion in year to date outflows according to RIA Intel.

Before we declare the sustainable investing party over, let’s look at the data.

While that $5.2 billion figure might lead you to believe that sustainably-minded investors are giving up, it’s only half the story.

What happened is that BlackRock stopped using $6.5 billion worth of an ESG fund as a target holding in one of its actively managed portfolio models. When the iShares ESG Aware MSCI USA ETF was replaced by iShares MSCI USA Quality Factor ETF, the former was sold and the latter purchased.

There are three important points worth mentioning.

First, that $6.5 billion in outflows is the result of one shareholder’s decision to exit the fund. This doesn’t mean the public has thrown up their hands and given up on ESG investing.

Second, if $6.5 billion in ESG outflows occurred in March because of the portfolio adjustment, then this means all other ESG investors actually added $1.3 billion in assets to net the reported $5.2 billion in outflows.

Third, the $5.2 billion of ESG asset outflows for the quarter only represents a 1.4% decline in total ESG invested assets. When framed in dollars, it sounds scary. When reported as a percentage, it’s not a big deal.

FAST FORWARD TO TODAY

Overall, ESG fund outflow trend has been real (Exhibit 1 below) the last few years.

Source: US ESG Fund Flows Continue to Improve in Q3, Morningstar, Oct 25th 2024

Although ESG funds have been losing more assets than they’ve been attracting, let’s keep a few things in mind.

  • According to US SIF, sustainable investing represents $6.5 Trillion, or 12% of the overall $52.2 Trillion market. That’s still a relatively healthy percentage of ESG screened funds.

  • For every ESG-branded fund in my screening software, I see 2 to 3 non-ESG-branded funds that also score well. This tells me that fund managers are likely making ESG-related decisions without actually labeling their strategies as ESG.

  • Despite strong performance against conventional funds throughout the early pandemic, investors bailed on their funds when the market declined in 2022. This isn’t an ESG-only phenomenon. It’s an irrationality all investors can fall prey to.

  • According to Reuters, ESG funds saw inflows of $20.5 billion in just the 4th quarter of 2020. This caps off a massive $51.1 billion worth of ESG fund inflows for all of 2020.

  • In the 3rd quarter of 2024, ESG funds saw $3.6 billion in outflows. However, these outflows were dominated by actively managed funds. By contrast, index fund-based ESG strategies (like what we use at Aspen Leaf Wealth Management) showed inflows of $1.3 billion.


CONCLUSION

When my clients ask if ESG investing is dying, I respond by saying the data doesn’t support that claim.

News outlets care about stories and clicks more than they do about actual journalism.

Despite how the financial media spins ESG-related news or what some “expert” thinks about the political landscape of ESG investing, it’s more likely that proper ESG analysis will continue to provide insights for asset managers serious about understanding long-term investment risk as well as opportunity.

I’m not losing any sleep, and neither should you.

Greg Lessard