Sustainable ETFs Hit a Rough Patch

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    Stockholm (NordSIP) – According to Morningstar’s latest ETF flows report, investors have failed to warm up to sustainably-labelled products so far this summer. Last month, ESG ETFs continued bleeding, pushing their 2023 outflows to nearly USD 7 billion. The trend is striking, as July was another solid month of fund inflows overall, with equity ETFs collecting USD 45.6 billion and their bond peers reeling in USD 15.8 billion of fresh investment.

    “Sustainable ETFs were once the hot new item on the ETF shelves, but flows into these products ground to a halt and reversed,” write Morningstar’s analysts. Without providing any clues as to the possible reasons for this apparent trend reversal, the report states that sustainable ETFs shed USD 1.2 billion in July, which is roughly equivalent to another 1.2% of their asset base.

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    The biggest loser among these funds was iShares ESG Aware MSCI USA ETF, “a broad, light-touch sustainable fund” that has seen outflows of USD 8.9 billion year-to-date, the most among all ETFs on the market. “The story hasn’t been much different for narrower impact strategies,” however, comments Morningstar. According to them, funds listed under the “energy transition” theme have collectively lost USD 892 million in 2023.

    Providing an exception to the rule, one theme, “resource management”, has managed to gather USD 202 million in investments this year.

    Is it performance?

    The outflow from sustainable strategies at the beginning of the year was hardly a surprise, as investors focused on the disappointing performance in 2022. Last year, ESG-themed ETFs were at a considerable disadvantage due to lower weightings in the energy sector. Yet sustainable funds’ inbuilt sector allocation biases have played out mostly favourably this year. Performance has largely recovered, buoyed by allocations to tech and communications. In many cases, returns of sustainable funds are keeping up with those of peers or exceeding them, at least in the short term.

    If returns were indeed one of the reasons behind the outflows, we might still see a turnaround during the third quarter, as fund flows tend to lag significantly in their response to performance. Something similar happened in 2022 when the most substantial outflows from sustainable funds came later in the year, once their performance was already reversing. However, there is nothing in the latest data yet to suggest such a turnaround.

    ESG confusion

    Another factor that has undoubtedly damaged the image of ESG ETFs, as well as sustainable products in general, and might have contributed to the outflows is the ongoing political backlash in the US. Even disregarding the controversy and politicizing surrounding the issue, investors are struggling to grasp the actual complexity of the question of what is or isn’t ESG. Faced with such complexity, they might opt to retreat to plain vanilla investment products.

    Whatever the reason, the outflow trend seems to be a persistent one. “A market-share cannibal as recently as two years ago, sustainable ETFs have hit a rough patch in 2023,” concludes Morningstar.

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