Global quarterly flows into sustainable funds have plummeted since 2021.Khanchit Khirisutchalual/iStockPhoto / Getty Images
Environmental, social and governance (ESG) investing has lost momentum, and some of the backlash boils down to a lack of definition. If asset managers, investors, regulators and – yes – politicians can’t agree on what makes a fund ESG (or sustainable, or responsible), then faith in the strategy is shaken.
Global quarterly flows into sustainable funds have plummeted since gathering more than US$150-billion in the fourth quarter of 2021, according to Morningstar.
- Only about US$4.3-billion of net new money went into sustainable mutual funds and exchange-traded funds in the second quarter of 2024, after outflows of US$2.9-billion in the first quarter.
- Product development has also slowed, with 77 new funds introduced globally in the latest quarter, compared with several consecutive quarters in 2021 and 2022 that each saw more than 200 new sustainable funds launched.
Chris Fidler, head of global industry standards at the CFA Institute, says investor confusion has contributed to the slowdown.
“In not having clear definitions, it’s allowed a situation to arise in which people can define [ESG] any way they want,” he says.
The CFA Institute is trying to tighten up those definitions. The organization released a new classification system this week that aims to help regulators draft and refine their ESG frameworks, and to help advisors explain and recommend products to clients. Part of the goal is distinguishing between funds that try to satisfy investors’ moral preferences from funds that don’t.
The paper classifies ESG funds by three features. The descriptions in the report are lengthy and complex, but here’s a rough breakdown:
Processes that consider ESG information to improve returns: This feature doesn’t claim to consider any particular ESG issue or avoid specific negative impacts to the environment or society, but “ensures that relevant ESG risks and opportunities are priced.”
Mr. Fidler says funds in this category use ESG information (carbon footprint, for example) as an input to achieve the product’s risk and return objectives.
Policies that control funds’ exposure and contribution to specific ESG issues: Certain actions will or won’t be taken based on the fund’s policies, but this doesn’t mean that a fund contributes to environmental or social outcomes.
“What you’re looking for is some certainty that the fund will or will not invest in certain companies or certain types of companies,” Mr. Fidler says. That could be for ethical or financial reasons.
A plan to bring about a specific outcome in environmental and/or social conditions: These funds most often satisfy an investor’s moral preferences, although they may also contribute to returns.
This covers the limited number of funds that commit to achieving real-world outcomes, Mr. Fidler says. Examples include deploying 20 billion gallons of water to regions with water shortages or building a certain number of new affordable housing units.
So how could the classification system help advisors? Mr. Fidler says some advisors worry about having appropriate investment products to offer after initiating a conversation about ESG investing.
The paper proposes advisors ask clients the following to determine the type of ESG fund they’re seeking and have investment solutions available based on the answers:
Which fund would you most prefer?
- A fund that considers environmental, social, and governance information if and only if such information is relevant to the fund’s risk and/or return objectives
- A fund that has committed to take, or refrain from, specific actions related to certain environmental, social, and governance issues
- A fund that has an objective to help bring about pre-specified environmental and/or social outcomes in addition to a financial return, or
- A fund that does not consider environmental, social, and governance information, issues, or conditions in any way or for any purpose.
“You do have to keep it simple,” Mr. Fidler says, “because investing is complicated enough.”
– Mark Burgess, Globe Advisor assistant editor
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