Sustainable fund outflows aren't fazing advisors

Investors continued to pull money out of sustainability-themed funds during the second quarter amid a political backlash against ESG — but that trend is unlikely to sway advisors who are true believers in the cause.

Between April and June, a total of $635 million poured out of U.S. sustainable mutual funds and ETFs, representing the third consecutive quarter of net outflows, according to data released this week by Morningstar. The recent figure is much lower than the redemptions seen during the first quarter of 2023 and the fourth quarter of 2022 — both of which were more than $5 billion. But it nonetheless contrasts with positive sales for the full roster of U.S. funds, which pulled in $20 billion in the second quarter.

The results come as Republican representatives in Congress are holding a series of hearings and bill markups this month focused on ESG. But they also come at a time when the performance for sustainable funds has turned around.

Although ESG-themed products were at a performance disadvantage in 2022, due to their lower weightings in the energy sector, they have been buoyed this year in part by allocations to tech and communications. As of midday Friday, the year-to-date return on the S&P 500 Index was 18.9%, compared with 20.5% for the S&P 500 ESG Index.

“The political battle over ESG continues, although I’m inclined to believe that the House Oversight Committee’s ESG hearings this past quarter backfired a bit on ESG antagonists, as the takeaways from those hearings seemed to uncover and emphasize some important truths about sustainable investing, including that ESG is fundamentally just more data, and it is financially material data that fiduciaries (and individual investors) can use to seek improved investment outcomes — or to ignore at their peril,” David Tenerelli, a financial planner with Strategic Financial Planning, said in an email.

It might also help that returns of sustainable funds in many, if not most, cases are keeping up with those of peers or exceeding them — at least in the short term. It's possible that fund flows respond significantly after the fact to performance, meaning that sales could turn around during the third quarter.

“What we saw in 2022 when performance for ESG funds was definitely challenged, almost universally across the board, was that the strongest outflows from sustainable funds came later in the year, when performance was reversing,” said Alyssa Stankiewicz, associate director of sustainability research at Morningstar and author of the report on fund flows. While sustainable funds in the large blend category lagged their conventional peers in 2022, they nonetheless had higher annualized returns over three- and five-year periods, she said.

IT'S THE CLIMATE

During the second quarter, the top-selling sustainable funds were those that focused on climate issues, Stankiewicz noted. Those products were the $2.25 billion iShares Climate Conscious & Transition MSCI USA ETF, which pulled in $2.17 billion; the $2.21 billion Xtrackers MSCI USA Climate Action Equity ETF, with $2 billion in net sales; and the iShares Paris-Aligned Climate MSCI USA ETF, which attracted $451 million, according to the report.

The sustainability-themed products that were the biggest bleeders were also products of those same firms. While climate-focused funds drew the most new money, products that have general ESG strategies were among those with net outflows, Stankiewicz said. The $1.1 billion iShares ESG MSCI USA Leaders ETF saw $2.26 billion leave, while the $1.24 billion Xtrackers MSCI USA ESG Leaders Equity ETF had $2.11 billion in redemptions, and the $14.6 billion iShares ESG Aware MSCI USA ETF saw $679 million flow out.

The latter product, with the ESGU ticker, remains one of the biggest sustainable funds on the market, although it was the biggest bleeder in the first quarter, with more than $6 billion going out. The biggest fund, the nearly $27 billion Parnassus Core Equity Fund, saw $233 million depart during the second quarter, according to the Morningstar data.

Most of the outflows during the second quarter were from actively managed sustainable funds, a reversal from what was seen in the first quarter. And while equity funds were in net outflows, sustainable bond funds saw positive sales of $288 million.

Tenerelli, whose RIA is focused on conventional investments, obtained a Chartered SRI Counselor designation last year and is hoping to incorporate sustainable investing more at the firm, he said.

“I suspect the recent deluge of news stories about accelerating climate change, biodiversity loss, and ecological collapse will help my case,” he said.

WHAT CLIENTS WANT

Advisor Kevin Cheeks, founder of ImpactFI, said he focused on long-term results and has not recommended dramatic changes to client portfolios in response to sustainable fund returns this year or the political campaign against ESG.

“It really comes down to what’s important to the client and the client’s goals and maintaining that longer-term perspective,” Cheeks said.

His clients favor sustainable investing generally, though some are more focused on specific issues such as climate change. And because of a lack of sustainable fund options in certain asset classes, their portfolios are not 100% ESG, he noted.

Meanwhile, the complexity around what is or isn’t ESG can be a problem for some clients, Chris Chen, wealth strategist at Insight Financial Strategists, said in an email.

“Clients are confused, but they do want ESG. At this point, if we can show that a fund does ESG, that's usually enough. However, it is complex, so people will often retreat back to standard vehicles because it is so complex,” Chen said. “I am looking forward to using the personalization features with direct indexing. That has the potential of giving the client a measure of additional control on what they mean by ‘ESG.’”