U.S. inflows into sustainable funds fell to $3.1 billion in 2022, according to a new Morningstar report, as rising interest rates, oil prices, and inflation battered markets. That’s the lowest level for sustainable fund flows since 2015 and a pronounced shift following several record-setting years in 2019, 2020, and 2021.
Things weren’t any better for the broader fund landscape either. Overall U.S. fund flows shed $370 billion in 2022, marking the first year of outflows since Morningstar began tracking this data.
In that light, sustainable funds – which focus on investment strategies that range from managing environmental, social, and governance (ESG) risks to making an impact on climate change – remained relatively resilient with a net $3 billion in sales in the face of market pressures and a growing backlash against ESG investing.
“There is a combination of factors that are driving that resiliency,” Alyssa Stankiewicz, associate director at Morningstar Research, told Yahoo Finance. “One likely has to do with personal motivation on the part of investors. The fact that a lot of sustainable funds have sort of a dual mandate that they’re targeting … I think that leads to probably a stronger connection with these funds’ mandates on the part of some investors, not all investors, but some.”
Another factor that drove resiliency, Stankiewicz added, was the long-term performance of sustainable funds.
While sustainable funds underperformed the broader market in 2022 – with stocks suffering the most – they continued to deliver better returns than their conventional peers over the trailing three-year and five-year periods.
“You never really know sort of the merit of an investment strategy until you see it, so to speak, get punched in the face by market headwinds,” Stankiewicz said. “And I think 2022 was that punch in the face for some sustainable funds. So in light of that, I think it was actually encouraging to see that they performed in line with what you would expect, and it didn’t erase that intermediate-term outperformance.”
And although sustainable funds suffered through an unusually brutal year, some trends didn’t change.
Investors continued to see more choices in the kinds of sustainable investments available to them. The industry added 87 new funds in 2022, bringing the total up to 598, according to Morningstar. While the pace of new product launches slowed, the number of new funds still managed to increase by 12% from 2021.
Stankiewicz noted that as the industry evolves, portfolio managers have expanded from building out sustainable versions of core portfolio offerings to creating more thematic and targeted products.
“Five years ago, there may have been zero choices for a core bond allocation, [and] there were very few choices for a sustainable municipal bond allocation,” she said. “As those products have been around developing track records, developing asset bases, they’re becoming more investable for folks that are building out a diversified portfolio.”
ESG funds stagger back
Sustainable fund flows fluctuated significantly from quarter to quarter last year.
The first quarter of 2022 kicked off with strong flows into sustainable funds, which ultimately buoyed net funds for the year. However, demand waned in the second quarter and saw only a modest rebound in the third quarter before declining sharply in the fourth quarter.
Passive funds continued to dominate sustainable fund flows as investors withdrew from actively-managed ones. And fixed-income fund flows surpassed flows into equity funds for the first time.
Another notable development was the unseating of BlackRock (BLK) as the top asset manager in terms of the most sustainable fund inflows for the year.
The top spot in 2022 went to Vanguard with $1.84 billion in net flows, followed by American Century and Brown Advisory.
BlackRock, meanwhile, fell to the fifth spot, raking in just $620 million in net flows as compared to $25 billion in 2021.
The world’s largest asset manager came under fire in 2022 after it became embroiled in the backlash to ESG investing. That backlash culminated in a series of open letters in which states such as Texas and Florida vowed to divest from BlackRock over its alleged boycott of fossil fuels, despite ongoing investments in oil and gas.
In January, BlackRock CEO Larry Fink, a key advocate for stakeholder capitalism, lamented the political polarization of ESG, indicating that the conversation around ESG is far from over.
“I’m taking this very seriously,” Fink said at the World Economic Forum. “We are trying to address the misconceptions. It’s hard because it’s not business anymore – they’re doing it in a personal way. And for the first time in my professional career, attacks are now personal. They’re trying to demonize the issues.”
But there are other factors that may have contributed to the waning demand for BlackRock sustainable funds beyond the controversies that dominated headlines.
Three of BlackRock’s iShares ETFs under the tickers ESGE, SUSA, and SUSL were among the top funds that saw outflows in 2022. One explanation for this is that BlackRock revised its recommendations for its Target Allocation ETF series, which had nearly $40 billion in assets under advisement as of March 2022.
Meanwhile, Vanguard’s Vanguard ESG US Stock ETF (ESGV) was second in terms of inflows.
“The fund features a straightforward approach to portfolio construction that harks to the early days of socially responsible investing,” Stankiewicz said. “It tracks a diversified equity index that screens out firms involved in tobacco, cannabis, civilian firearms, and coal and oil. The fund’s popularity is largely driven by its low fee of just 9 basis points.”
Despite the challenges that sustainable funds (along with many other assets) faced in 2022, Stankiewicz said it’s simply part of the industry’s growing pains.
“I think the increased attention on this space from politicians, other regulators, other stakeholders is maybe a natural and sort of welcome spotlight to advocates in the space to be very clear about what they mean,” she said, “so that investors really fully understand what they’re looking at when they’re making the decision to invest in a sustainable fund.”