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The Dramatic Downfall of ESG Investing

Investors are withdrawing money from sustainable funds as the ESG enthusiasm of the past few years is waning amid high interest rates, poor returns, plunging renewable energy stocks, tightened SEC rules, and political backlash.   

Over the past year, investors have withdrawn a total of $14.2 billion from U.S. sustainable funds in four consecutive quarters of net withdrawals, data from Morningstar showed.

Green Energy Stocks Battered 

Globally, renewable energy funds saw record outflows of money in the third quarter of 2023 as stocks of wind and solar developers and suppliers crashed amid rising costs, higher interest rates, and supply-chain challenges.

Renewable energy exchange traded funds (ETFs), tracking the performance of clean energy companies, suffered a total of $1.4 billion of outflows in the third quarter, the highest outflows of any previous quarter, according to data from LSEG Lipper cited by Reuters.

The record outflows between July and September only partially offset net inflows of $3.36 billion for the first half of 2023, the data showed.

A perfect storm of soaring costs, supply chain delays, rising interest rates, and low electricity prices at auctions have been hurting renewables-related companies in recent months.

"There's a dark cloud hanging over green stocks," Martin Frandsen, a portfolio manager at Principal Asset Management, told the Financial Times last month.

Investors Pull Billions From U.S. Sustainable Funds 

It's not only the recent flop in renewable energy stocks that's keeping Wall Street away from sustainable investments. The high interest rates and politicians targeting sustainable investing have also played a role in investor decisions, industry executives and analysts say. 

In the third quarter of 2023 alone, investors pulled $2.7 billion from U.S. sustainable funds, continuing a trend of net withdrawals that started in the fourth quarter of 2022, per data from Morningstar Direct. 

"Although the motivations behind outflows cannot be perfectly quantified, many factors are in play. These include rising energy prices, high interest rates, concerns about greenwashing, and political backlash," Alyssa Stankiewicz, an associate director of sustainability research for Morningstar, wrote in an analysis last month.

All U.S. funds also saw net withdrawals in the third quarter of 2023, but the demand drop in sustainable funds was steeper compared to conventional funds, according to Morningstar. 

As a result of net withdrawals and poor performance, assets in sustainable funds dropped back below the $298.8 billion mark at the end of the third quarter-falling by 17% from the record-high of $358.2 billion at the end of 2021 but up by 10% from the recent low of $272.2 billion in the third quarter of 2022, Morningstar data showed. 

Moreover, for the first time ever, more sustainable funds closed in the third quarter than the number of funds launched. Three new sustainable funds launched, and one existing fund was added to the sustainable funds landscape in Q3, while 13 sustainable funds closed and four funds moved away from ESG mandates, Morningstar said. 

Columbia Threadneedle, Hartford, and BlackRock liquidated the largest sustainable funds in terms of assets in the third quarter. 

As a result, the total number of sustainable open-end and exchange-traded funds in the United States were 661 at the end of the quarter. 

After the third quarter, the list of the top 12 worst-performing ETFs in October was packed with thematic funds in the clean energy space, according to Morningstar Direct research from early November. Electric Vehicle Charging Infrastructure UCITS ETF, First Trust Nasdaq Clean Edge Green Energy UCITS ETF, and the Invesco Solar Energy UCITS ETF were the biggest ETF losers. 

New Rules And Political Backlash Discourage Sustainable Fund Investors

In recent months, the Biden Administration's rule allowing employee retirement plans to consider ESG factors in investment decisions has been challenged by Republican-led states. Fund managers say the rule may have impacted the popularity of sustainable funds. 

"We found that the demand for ESG investing, by financial professionals working with retirement-plan participants, was more limited than we anticipated," Ron Rice, vice president of marketing at Pacific Financial, told The Wall Street Journal

In addition, the Securities and Exchange Commission (SEC) has been stepping up efforts to combat the greenwashing of labeling funds as sustainable. The SEC updated in September the so-called Names Rule, requiring 80% of a fund's portfolio to match the asset advertised by its name. 

"The updated rule will apply not only to funds whose names suggest a focus in particular investments, industries, or geographies-but also to funds whose names suggest a focus in investments with particular characteristics. This includes names suggesting an investment focus on Environment, Social, and Governance (ESG)-related factors through names such as "sustainable," "green," or "socially responsible," SEC chair Gary Gensler said. 

In addition, sustainable investing in the U.S. has been criticized by Republican states, most notably Texas, which says that ESG standards are harming America's energy industry and threatens millions of jobs. Texas prohibits state contracts and investments with companies that boycott energy companies.

At the end of last year, the Florida Treasury said it would divest $2 billion worth of assets under management by BlackRock because of the ESG investing by the world's largest asset manager. 

"If Larry, or his friends on Wall Street, want to change the world - run for office," Florida Chief Financial Officer (CFO) Jimmy Patronis said at the time.

"Using our cash, however, to fund BlackRock's social-engineering project isn't something Florida ever signed up for."   

By Tsvetana Paraskova for Oilprice.com 

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Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews.  More