More 'ESG' funds folding this year, but others are taking their place

A handful of asset managers have been pulling the plug on ESG-themed funds they launched several years ago — a result they all but certainly knew was coming, as not every attempt to get a slice of that booming market was going to work.

That hardly means that sustainable investing is on the decline. The number of products continues to grow, as do the total assets in them. But fund companies might have to do more to stand out, whether that means offering unique investments or showing that their strategies are genuine ones in a field rife with claims of greenwashing.

So far this year, firms have shuttered 26 “sustainable” mutual funds and ETFs in the U.S., a rate roughly three times that seen during the first eight months of the prior three years, according to Morningstar Direct data recently cited by Bloomberg. Shops closing products included BlackRock, State Street, Columbia Threadneedle, Janus Henderson and Hartford Funds, the publication noted.

While those closures followed mounting pressure from Republican groups to abandon ESG considerations, they are not necessarily any indication that asset managers are stepping back from sustainable funds.

On Wednesday, BlackRock’s iShares filed with the Securities and Exchange Commission for a new ETF that would invest in large- and mid-cap international stocks to build a Paris Agreement-aligned portfolio, meaning that the holdings would reflect climate-change goals of limiting global warming to less than 2 degrees C this century. Days before, the company had filed for an iShares Energy Storage & Materials ETF, which would invest in companies focused on the transition to a low-carbon economy.

This week, BlackRock also launched its Climate Transition-Oriented Private Debt Fund, according to Bloomberg. Another firm, DWS, recently filed for an Xtrackers S&P 500 Carbon Budget ETF.

Climate-focused funds have been a major area of development for fund companies, although the pace of new products has slowed since peaking in 2021, according to a report last month by Morningstar. In 2021, 34 such funds came to the market, followed by 25 in 2022 and eight during the first six months of 2023. As of June,the U.S. climate-themed funds held $31.7 billion in assets, a 4% increase over 18 months that did not follow more rapid growth seen across Europe, the report noted.

The number of sustainable mutual funds and ETFs in the country reached 656 as of the end of June, representing an 11% increase year over year, Morningstar’s separate Sustainable Fund Flows report stated earlier this year.

“There’s a lot more being developed around sub-asset classes under the ESG umbrella,” said Sarah Hamilton, partner and wealth advisor at Hamilton Walker Advisers.

About half of Hamilton’s clients opt for some level of ESG mandate in their portfolios, she noted. That high proportion is a result of Hamilton's holding herself out as a subject matter expert, attracting clients who are specifically interested in sustainable investing, she said.

Niche products range from being focused on vegan investors to those who want to see gender diversity on corporate boards, she noted. That level of specificity has allowed her to fine-tune portfolios for clients who are interested in particular issues, Hamilton said.

Additionally, the expansion of separately managed accounts and direct indexing, which lets investors screen out companies and hold stock directly, has been a helpful development for some clients, she said.

“Investors are increasingly seeking clarity about the role environmental and social factors play in the investment (portfolio construction) and stewardship (proxy voting, engagement) processes,” Alyssa Stankiewicz, associate director of sustainability research at Morningstar, said in an email. “Think ‘truth in marketing’ but going a few steps further.”

Increasingly, “ESG” refers to risk mitigation, often in diversified portfolios, Stankiewicz said. Those might screen out fossil fuels, tobacco and weapons but might be less concentrated in “best-in-class” ESG companies than funds that call themselves sustainable, she said.

Going further are impact funds, sometimes called “thematic” funds, which are the most concentrated in high-ESG performers and often provide impact reports, Stankiewicz said.

It’s now expected that fund companies will issue periodic reports on proxy voting and engagement, she noted.

“Asset managers that seek to differentiate themselves on sustainability matters should prepare to be consistent in their messaging and commitments across markets,” Stankiewicz said. “High-conviction sustainability-focused investors likely expect firms to uphold sustainability issues even in the face of political backlash.”

Hamilton said she works to educate clients about the differences between merely OK sustainable funds versus good or excellent ones, the latter of which not only apply screens for investments but also engage with portfolio companies. But beyond that, people should pay attention to fees and performance — investments shouldn't get a pass on that just because they are sustainable, she said.

“You need to do some research. Just because you call something ‘ESG’ doesn’t mean it’s a good investment,” Hamilton said. “You shouldn’t have to give up massive amounts of returns to invest this way.”