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Normally FT Alphaville is loath to write about anything ESG-related. Aside from crypto, no other subject reliably produces the same torrent of wishy-washy press releases (AI and private credit are close though).
But this is interesting enough to swallow our misgivings: Although buoyant markets are still lifting their overall assets under management — now at apparently over $1.7tn — ESG funds are suffering severe outflows for the first time in their (admittedly limited) history this year.
[H/T SocGen’s Arthur van Slooten, whose report on the subject drew our attention to the “unusual” $38.5bn year-to-date outflows.]
Last year was pretty weak, with net inflows of just under $17bn, but 2023 was a terrible year for equity fund flows in general, with non-explicitly ESG funds suffering $19bn of investor outflows, according to EPFR. In this context — and with the broadening backlash by then — the ESG inflows are almost impressive.
ESG funds also belied broad stock market fund outflows in 2022, when they took in over $68bn. And in 2021 investors put over $300bn into ESG equity funds, which remains the high-water mark for the industry’s fund flows.
The recent outflows can’t be based on dismal markets and broad outflows either: global equity funds that don’t explicitly market themselves as ESG-focused have taken in $216bn already this year, according to EPFR’s data.
Van Slooten reckons that the outflows are mainly due to the underperformance of a lot of mainstream ESG indices and approaches, and argues that an “overhaul” of the strategy — naturally including more analyst forecasts — would be better:
Multiple causes for the underperformance of ESG ‘benchmarks’. As mentioned earlier, we don’t blame this on the ESG principles themselves, but rather on the narrow interpretation of these principles, which has led to some issues. Aspects to re-consider are the outright exclusion of certain sectors and the over-concentration on a limited number of industries (notably solar and wind). In general, the reliance on static historical data and rankings creates a bias to small and mid-cap sized companies that exposes investors to specific sector risks.
Back to the future. For ESG funds, providing an attractive balance between risk, performance and ESG related goals is essential. Overcoming the flaws of static ESG asset management requires a new approach that is based on companies’ progress on ESG-related issues. This assessment requires a sound methodology, preferably based on quantifiable criteria, and the inclusion of analyst forecasts where possible. While all ESG criteria are equally important, we found that the energy component, with its specific pollution metrics, is probably the best suited for such a dynamic approach.
Flows have stabilised a little lately — as you can see from the first chart — so maybe this was just a blip caused by the underperformance of a lot of clean energy stocks, the commodity price run and the US-centric backlash.
But given how much asset managers love to talk about the subject (and the higher fees ESG products usually charge), many in the investment industry will be hoping for a comeback.
