By Isla Binnie and Ross Kerber
NEW YORK/BOSTON (Reuters) - Funds adhering to environmental, social, and corporate governance (ESG) principles have been hit by unprecedented outflows in the market downturn, as investors prioritize capital preservation over goals such as tackling climate change.
ESG, a classification applied to fund assets currently worth an estimated $6.5 trillion, is being tested by a drop in market values fuelled by concerns that central banks hiking interest rates to fight rampant inflation will trigger an economic recession.
Investors souring on ESG funds could pose a challenge to governments seeking to enlist them in the fight against climate change. Policymakers at the COP27 climate talks in Egypt are trying this week to secure more financing from the private sector to help lower carbon emissions.
Data from research service Refinitiv Lipper shows that funds of equities, debt and other asset types dedicated to responsible investing posted net outflows globally of $108 billion this year to the end of September, the first time investors withdrew money from them over such a long period since Refinitiv started tracking them in late 2017.
Moreover, investors pulled money out of responsible investment funds - defined as such because they use criteria like ESG or religious values in their investment decisions - faster, relative to their size, than broader market funds for all but two months of 2022 through September, the data shows.
Refinitiv Lipper analyst Otto Christian Kober said the ESG fund industry's heavy exposure to the technology sector, which is seen as environmentally friendlier than other industries, became a drag amid fears of an economic slowdown. Its aversion to fossil fuels during a rally in energy prices weighed further on its financial performance.
"In the COVID-19 pandemic, investor sentiment was driven by ESG and maybe sinking energy prices. Sentiment turned around when natural resources or energy prices started to rise again and people said 'we need that return,'" Kober said.
GRAPHIC: Cash flowing into ESG funds takes a dive https://graphics.reuters.com/ESG-FLOWS/gdvzqrlmmpw/chart.png
To be sure, investors in some regions are showing more loyalty to ESG than in others. U.S. investors, for example, have stuck with responsible investing funds for more of year as their European counterparts fled, the Refinitiv Lipper data shows.
GRAPHIC: Regional ESG fund flows https://graphics.reuters.com/CLIMATE-CHANGE/klvygeagkvg/chart.png
The extent of investors' flight also hinges on how data providers define ESG funds. Morningstar Inc, which categorizes $2.24 trillion worth of funds as "sustainable" by applying more restrictive criteria than Refinitiv Lipper, reported a 71% year-on-year drop in inflows to $139 billion for the year through September.
REVERSAL OF FORTUNES
The recent downturn demonstrates that ESG investors' attention to the needs of the planet and society does not make them indifferent to poor financial returns when their portfolios underperform, investors and analysts said.
Only 31% of actively managed ESG equity funds beat their benchmarks in the first half of 2022, compared to 41% of conventional funds, according to Refinitiv Lipper.
This represents a reversal of fortunes compared to the previous years. In 2021, 40% of actively managed ESG funds beat their benchmarks, almost as well as conventional funds. In 2020, the actively managed ESG funds did even better; 57% of them beat their benchmarks, while only 43% of conventional funds did so.
One active ESG fund that has suffered in the downturn is Parnassus Core Equity fund. It had net outflows of $464 million during the third quarter and a total return of negative 21.47% for the 12 months through Nov. 9, beating only 30% of peer funds, according to Morningstar.
Joe Sinha, chief marketing officer of fund parent Parnassus Investments, said the firm's avoidance of fossil fuels had hurt returns and appeal with some investors, but added that some of the outflows were due to clients moving to other products within the firm.
"The people who are selling tend to be more trigger-happy based on recent performance," Sinha said.
It's possible that market trends will come to favour the portfolios of ESG funds in the coming months. Energy prices could fall amid an economic slowdown and bargain hunters may sweep in to buy some of the battered technology stocks.
"You typically see when we may already be close to the bottom of the market people tend to chase performance," said Jens Peers, CEO and CIO at Mirova US, a sustainable-investing arm of French bank Natixis.
(Reporting by Ross Kerber in Boston and Isla Binnie in New York; Editing by Greg Roumeliotis and Lisa Shumaker)