The focus on environmental, social and governance (ESG) is part of a wider strategy known as sustainable investing. Broadly, the goals are to achieve societal impact, align with personal values or manage risks.
But a boom in the use of ESG factors in the financial world has fed scepticism that the approach is nothing more than a marketing gimmick, fuelling a backlash and regulatory crackdown.
US fund managers have suffered their worst-ever quarter for ESG-focused products as the pace of client redemptions intensified.
Client withdrawals from US funds targeting ESG goals reached $8.8bn in the first three months of 2024, according to Morningstar Inc. That stood in stark contrast to the roughly $11bn of inflows into ESG funds in Europe, where sustainable investing regulations are far more entrenched.
It’s also the latest sign that US investors are turning their backs on the investment strategy, which has been targeted by high-profile Republicans.
At the same time, many core ESG industries such as wind and solar have suffered setbacks, leading to poor returns and further alienating many investors.
The development comes as investors wait to see how elections across the globe affect green policies that are likely to impact ESG investment strategies.
In the US, Donald Trump and President Joe Biden are polling neck-and-neck. On the other side of the Atlantic, European Parliament elections are likely to give parties that have voiced scepticism toward green policies a bigger foothold in the bloc’s legislature.
ESG was developed about two decades ago by United Nations officials working with the finance industry. They argued that weighing key ESG risks, such as climate change, worker disputes and litigation stemming from poor corporate governance, helps protect investments.
As time passed, the ESG label has been slapped on investments that run the gamut from owning green-energy stocks to things like funds that track benchmark bond indexes containing oil companies or assets in nations such as Russia.
According to Morningstar, ESG and sustainability labelled funds had almost $3tn of assets at the end of 2023.
ESG risks have become all the more prominent as extreme weather events and worker strikes have hurt automakers, insurers and travel companies.
At the same time, in the US, some state officials have derided ESG efforts as “woke”, claiming they prioritise liberal values at the expense of financial returns.
It didn’t also help ESG’s cause that Russia’s invasion of Ukraine drove up oil stocks in 2022. While ESG funds recovered in 2023, they mostly underperformed market benchmarks.
For example in Europe, which has the biggest market, ESG-related funds rose about 16% on average, compared with the 24% gain of the MSCI World Index and the 16% return of the STOXX Europe 600 Price Index.
European and US regulators have now started to clamp down on firms they said were exaggerating their ESG bona fides.
In September, the US Securities and Exchange Commission adopted a rule that requires that 80% of a fund’s investments be in line with its stated focus. Revisions to European Union rules led fund managers to strip the top ESG tag from about €200bn ($215bn) of client funds from July 2022 to March 2023.
Some investors and academics complain that sustainable investing’s impact has amounted to far less than its supporters suggested.
Detractors also say the idea that sustainable investing alone is enough to address complex problems is being shown to be wrong and that more government intervention is needed to address societal issues such as minimum wages and rising greenhouse gas emissions.
Broadly, global sustainable investments are estimated to range between $35tn and $40tn.
Amid mounting concern that only a fraction of such assets are bona fide ESG investing, there are calls for tougher regulations to stamp out the false claims by fund managers.
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