Americans Cash Out of Sustainable Funds… into Sustainable Funds?
By: Alex Cote
You may have noticed the relatively new phenomenon where politicians now talk about ESG, and media outlets publish alarmist headlines revolving around ESG and sustainable investing…and they get clicks. Here’s a good one, and another one. Just a few years ago, ESG and sustainability were promising portfolio management inputs, and now they’re headline grabbers and maybe even illegal?
Last week, I was forwarded an article that a colleague stumbled across with a spooky-sounding title “Americans cash out of sustainable funds”. Which, as you might imagine, raised some alarms (and the heart rate of one sustainable public markets zealot). Our clients are Americans! They invest in sustainable funds! Are they conspiring to cash out of these sustainable funds? What about all of the data coming out that individual investors are extremely interested in sustainable investing? My heart rate was properly spiked.
The article gave a brief overview of quarterly data released by data provider Morningstar, pointing out that a net $8.8 billion dollars flowed out of US sustainable ETFs and mutual funds (I will come back to this later) in Q1. The reasoning provided in the article?
“When interest rates rise, that makes the future less valuable compared to the present. That's bad news for ESG investments, which broadly seek to bet on a brighter, greener future rather than on next quarter's cash flows.”
My public markets zealot gears started turning: there’s some logical intuition there, leaning on the hypothesis that public markets are wicked efficient at incorporating information like interest rates. But if markets were wicked efficient, wouldn’t these flows have happened when interest rates started to rise rather than when they were already high? The logical intuition, perhaps, wasn’t perfectly logical after all.
So, I turned to the referenced Morningstar data report itself to understand the numbers and two things jumped out:
“Two iShares funds accounted for almost the entire remaining 50% of the outflows. Investors pulled close to a combined USD 4 billion from iShares MSCI USA ESG Select ETF SUSA and iShares ESG Aware MSCI USA ETF ESGU during the quarter. In 2023, ESGU experienced outflows of more than USD 9 billion. Without this fund, sustainable passive funds would have netted just a bit more than USD 1 billion over calendar-year 2023.”
“During the first quarter of 2024, sustainable bond funds boomeranged back into positive territory with a modest USD 774 million collection.”
To break that down for the non-self-proclaimed-public-markets-sustainability-zealots:
Sustainable equity funds had a net outflow in Q1, while sustainable bond funds had a net inflow.
50% of the sustainable equity fund outflows came from the two BlackRock funds, which continues the trend of massive outflows out of ESGU in 2023.
This is probably a good place to mention that sustainable investors are becoming less enthused about BlackRock at an increasing pace for backing away from ESG.
Now, at this point, I was starting to get suspicious - was this article just distilling a 43-page report on a divisive topic into an attention-grabbing headline for clicks? Ok, I’ll be honest - at this point, it seemed like this was the case.
I felt confident about this conclusion because the article never drilled into the above bullet points and never asked the key question - if this money is flowing out of these funds, where is it flowing into?
To answer that, I want to revisit the scope of the research report in question - as I mentioned earlier, it was exclusively ETFs and mutual funds. There is another trend in investment management not captured by the article or report: the direct indexing portfolio management style is seeing immense inflows and meteoric traction. Meanwhile, our sustainable direct indexing partner, Ethic, just surpassed $5B in AUM on a path of similar inflows. Direct indexing has blown up in recent years as technological advancements have enabled it to become accessible, customizable, tax-efficient, and fee-efficient. Particularly, sustainable direct indexing offers sustainable investors an exponentially higher degree of sustainability customization than ETF or mutual fund investing while still offering the same impact tools of old like proxy voting and shareholder engagement.
As I sifted through this article and report, it became clear that the bulk of these outflows are coming out of one practice of sustainable passive investing (ETFs) into a newer practice of sustainable passive investing (direct indexing). It seems impossible that one brand of sustainable equity investor (sustainable ETFs) is “cashing out” in response to interest rates while another brand of sustainable equity investor (sustainable direct indexing) is piling in. So, maybe it’s not as grabby, but I’d like to boldly proclaim - Americans are cashing out of sustainable funds… and into sustainable funds.