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The BlackRock Investment Institute has forecast that the global transition to net zero carbon emissions is set to accelerate © Maurizio Gambarini/DPA/AFP/Getty Images

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The past year has felt bruising for many devotees of “sustainable” fund investing despite the growing attraction of products aligned with environmental, social and governance criteria.

Morningstar estimates sustainable funds attracted $22.5bn of net new money globally in the third quarter of 2022. That was less than the $33.9bn of inflows in the second quarter, but against a backdrop of significant market challenges, sustainable funds held up better than the broader market which experienced net outflows of $198bn over Q3.

But 2022 saw increasingly vocal criticism both from supporters of ESG and its “anti-woke capitalism” opponents. At the same time, regulators’ concerns about “greenwashing” spilled over into concerted action by some authorities. In November, Goldman Sachs agreed to pay a $4mn penalty to settle charges brought by the US Securities and Exchange Commission for policy and procedural failures in its ESG research. It did not admit or deny the charges, but agreed to a cease-and-desist order.

Earlier in the year, German police officers raided the offices of fund manager DWS after claims by a whistleblower that it had flaws in its ESG strategy. The police said they were investigating possible “prospectus fraud”. DWS has denied the whistleblower’s claims. Some industry observers are privately speculating which asset manager will be next.

The resulting bad publicity is not helping an industry that sometimes finds itself struggling to maintain the moral high ground.

For example, MSCI, the data and index provider, found in a recent study of Scope 1 and Scope 2 emissions — produced directly by companies or as a result of their activities — that the largest asset managers have the highest carbon footprint per $1mn invested.

Meanwhile, in the US, ESG funds have been condemned for being vehicles of “woke capitalism”.

By October, 10 US states had adopted anti-ESG regulations seeking to restrict public pensions plans and government entities from doing business with entities thought to be “boycotting” industries based on ESG criteria, according to law firm Morgan Lewis.

In December, Vanguard announced it would pull out from the Net Zero Asset Managers initiative, whose members have committed to achieving net zero carbon emissions by 2050.

For those hoping tighter regulation will make things clearer for investors, analysts say they should be prepared for a wait.

Hortense Bioy, global director of sustainability research at Morningstar, noted that 54 per cent of EU fund assets are now classified by their managers as either “light green” Article 8 or “darker green” Article 9 under the EU’s Sustainable Finance Disclosure Regulation. 

“These are high numbers, and I don’t think EU regulators expected the appetite for green investments to be so big,” said Bioy. “The regulator probably also underestimated the level of complexity and the confusion that the first set of rules brought.”

Column chart of $bn showing Europe leads the world in sustainable fund flows

One of the outcomes of the resulting confusion has been the swath of recent fund downgrades affecting tens of billions of client money.

“As we’ve seen, there has been a wave of declassification from Article 9 to Article 8 funds recently and this may continue until the EU Commission brings clarity on the definition of a sustainable investment,” Bioy said.

She pointed out that the global ESG universe gets even more complex with regulators in different jurisdictions pursuing different aims.

“ESG regulation in other countries like the UK and the US is focused on disclosure and protecting the end investor against greenwashing, with no broader objective. The EU regulatory agenda [which is partly to reorient capital flow towards ‘sustainable’ activities] is therefore unique,” Bioy said.

The fund management industry can sometimes find itself caught in sustainable regulatory red tape. In November, the European Fund and Asset Management Association complained about a “chronic” lack of corporate ESG data, despite the advent of new reporting requirements.

“Our industry will be left picking up the ESG data pieces in the meantime,” said Tanguy van de Werve, director-general at Efama.

Meanwhile, asset managers in the US are waiting for the SEC to roll out its own set of rules, expected in early 2023.

But does sustainable fund investment achieve its aims? Different sides of the debate point to contrasting research findings. Mauricio Vargas, economist with the activist group Greenpeace, recommended a 20-year-old study showing an exclusionary approach can achieve reform.

However, a more recent study last revised in October found that socially responsible investment funds do not improve the environmental or social conduct of their portfolio firms.

“[Socially responsible investing] funds select firms with lower pollution, more board diversity, higher employee satisfaction and better workplace safety. Yet, both in the cross-section and using an exogenous shock to SRI capital, we find SRI funds do not significantly change firm behaviour,” the authors write. “Our results suggest SRI funds are not greenwashing, but they are impact washing.”

Some investors might not care about those findings, because they can spot the ESG juggernaut coming down the road. The BlackRock Investment Institute, the asset manager’s think-tank, has forecast that the global transition to net zero carbon emissions is set to accelerate, noting it sees “opportunities in transition-ready investments” such as infrastructure.

With that sort of potential, it is perhaps understandable that some are ready to see the positive in the events of 2022.

“I don’t think it was an awful year for ESG at all. It was a rough year, but actually a good one, in that it has shed clear light on ESG’s limitations,” said Patrick Wood Uribe, chief executive of Util, a specialist ESG data provider. This year has shown managers they cannot market all ESG funds as impact funds.

“If there’s one thing I hope for 2023 it’s more transparency around this distinction,” Wood Uribe said.

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