Sustainability in crisis: Billions are flowing out of ESG funds. What lies ahead?

Implications for sustainable investments

The negative trend in ESG equity funds could have several implications for the broader market for sustainable investments. 

In the short term, there may be a continued shift back to traditional investments as investors chase higher returns. However, some experts believe that green assets will outperform in the medium to long term. For example, Paul Polman, the former CEO of consumer goods juggernaut Unilever, has made the case that ESG investing “pays off”. Microsoft co-founder Bill Gates has said that ESG investments “come with lower risk profiles”.

In my view, those investments can deliver competitive returns, because climate change remains a significant concern, and regulatory pressures will likely increase, making green investments potentially more attractive over time. 

Already, net inflows from ESG equity funds turned positive in May, Barclays said. Some wealth managers believe that ESG investments will perform better as the global economy recovers, with opportunities in energy transition and decarbonization. 

Lower valuations, improved regulations, and new sustainability labels from the UK’s Financial Conduct Authority (FCA) for investment funds with different sustainability goals also contribute to this positive outlook.

Furthermore, despite the challenges faced by green equity funds, ESG bond funds have continued to attract inflows, gathering $22bn by April of this year, according to Barclays. This trend suggests a nuanced investor preference for sustainable investments. 

One growing segment of green debt is bonds aimed at preventing biodiversity loss and protecting nature. These biodiversity bonds now represent nearly one-third of all ESG-labeled debt issued this year, up from 3% in 2015, according to Pictet Asset Management. The rise is driven by stricter regulatory frameworks, rising investor demand for sustainable investments, and favorable financial returns. 

ESG-labeled debt is particularly appealing to institutional investors like pension or sovereign wealth funds, which need to demonstrate their efforts in green investments. These bonds also provide a way for companies to improve their public image and raise capital to do good. 

Furthermore, with elevated interest rates globally, bonds with higher yields have become more attractive, making ESG debt an appealing option for investors seeking stable returns while hoping to make the world a better place. 

And while US political attacks on ESG investing have dampened investor sentiment, regulatory frameworks in Europe are generally more supportive of ESG investments. For example, the European Union has developed the EU Taxonomy, a classification system that defines what constitutes environmentally sustainable economic activities. This helps investors identify and invest in sustainable projects and activities. 

This increased transparency will likely make greenwashing more difficult and improve investor confidence in genuine ESG initiatives. 

These regulations are part of a broader trend towards increased accountability and transparency in corporate reporting, aiming to ensure that companies take genuine steps towards sustainability, rather than merely paying lip service to these goals.