After the worst quarter in its roughly two-decade history, ESG’s future is once again a subject of intense debate.

Against a backdrop of attacks by the Republican Party and lackluster returns, ESG funds in the US bled more than a net $5 billion in the final three months of 2023. Combined with a huge decline in the pace of inflows in Europe, the global market for funds claiming to pursue environmental, social or governance goals suffered its first-ever net redemptions last quarter, according to Morningstar Inc.

For some, it’s the latest nail in the coffin of an investing strategy that has become too politicized to survive. Industry executives close to the client flows in question offer a different picture.

Valentijn van Nieuwenhuijzen, head of sustainability for public market investing at Goldman Sachs Asset Management, says investors are witnessing a gradual maturation process that will culminate in ESG flows ultimately moving pretty much in lock-step with the rest of the market.

“As baseline sustainability integration increases, overall fund flows are likely to mirror broader trends in equity and fixed-income markets,” he told Bloomberg.

ESG is becoming a tool for investors to ensure their portfolios aren’t overly exposed to any one risk, he said. “Sustainability-focused investors are increasingly looking to products that target differentiated themes within ESG or add balance to broader portfolios,” according to Van Nieuwenhuijzen.

Hannah Lee, JPMorgan Chase & Co.’s head of ESG equity research for the Asia-Pacific region, says there’s little to indicate that ESG is about to disappear. She also acknowledges the investing strategy is going through a rough patch.

“There are still robust pockets of demand for ESG investing,” Lee said. “But the recent underperformance of sustainable funds has been a challenge.”

Last year, conventional green stocks were mostly a losing bet, with the S&P Global Clean Energy Index falling more than 20%. The index is down an additional 10% so far this year.

Investors redeemed roughly $13 billion from US-based ESG funds in 2023, the Morningstar data show. And even though flows into European ESG funds continued, it wasn’t enough to offset the declines in the US. In all, global net outflows totaled $2.5 billion in the fourth quarter, marking an all-time low for the ESG fund industry.

In Asia, where ESG has so far had less of a presence than in the US and Europe, JPMorgan’s Lee said the strategy’s weak performance relative to the wider market hasn’t helped. Morningstar estimates that $1.2 billion flowed out of Japanese ESG funds last quarter, while the rest of Asia saw negligible aggregate inflows, on a net basis.

“Performance has proved a headwind” and “flows to sustainable investing within the region have slowed,” she said. “But at the same time, the share of ESG funds being managed to a global mandate has grown to over 50%.”

Lee said it’s also “notable” that regulators across jurisdictions are hardwiring ESG into investing rulebooks. The upshot is that “sustainability remains firmly on the agenda,” she said.

Others in the industry are bracing for more pushback.

“Given the challenging past year,” there’s likely to be “heightened scrutiny” around the ability of sustainable investing to deliver, said Nicole Lim, an ESG investment manager in fixed income at Abrdn Plc. “This goes beyond concerns about greenwashing risks,” she said.

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