Outflows from sustainable funds might not be a bad thing
Global investors are reported to have sold a net $40 billion in sustainable equity funds in the first five months of 2024 as sentiment has soured on the investment approach – I think this is a good thing. Now before I get a deluge of hate mail, let me say I’m all in favour of sustainable investing and it is something we think is very important here at Forvis Mazars, and indeed we manage a lot of sustainable assets. But for a while now, I think the area has been due a bit of a shake-out in the interests of its long-term health.
The essential core of sustainable investing is providing investors with the option of aligning their money with their values – it’s a personal choice. Now the result of investing in a way that is different to the broad, general equity market is a divergence of returns. That divergence can be positive for sustainable assets, such as in 2020 with the onset of Covid-19 when a lot of polluting companies (fossil fuel producers, energy-intensive industry, etc.) had to essentially shut down. That divergence can also be negative, for example in early 2022 when Russia’s invasion of Ukraine caused oil prices to spike.
A key, possibly controversial, argument for sustainable investing is that you don’t necessarily have to sacrifice long-term returns. People will argue on logic grounds that placing any constraint on investing should lead to underperformance compared to an unconstrained investor. This is true in the abstract, where you can have perfect insight and foresight, but in reality markets are so inherently noisy and uncertain that all we have is perfect hindsight – which is absolutely no use in investing. The opportunity in this uncertainty combined with the long-term tailwind of global regulations and incentives to bring down carbon emissions means I see no reason that sustainable investing styles need to underperform. Diverge - yes, underperform – no.
The problem is that a lot of investors saw the strong performance of sustainable investment styles in 2020 and started to take “no reason to underperform” to mean “a structural reason to outperform”. The result was a flow of ‘hot money’ chasing returns and thinking they have found the latest trick that seems all but certain to consistently outperform. Now that we are seeing some of that negative market divergence, it appears those hot money flows (in many guises, including some governmental backlash in parts of the US) are draining out of sustainable funds.
Sustainable investing has a lot of tailwinds and I’m confident it will continue to grow over the long-term. Demographic patterns and generational shifts are having an impact. Whilst investors of all ages have an interest in this area, there has generally been the most interest from Gen Z who are typically in the quite early stages of saving and investing. However, we are also seeing older cohorts becoming much more interested, partly due to the great inter-generational wealth transfer effects, and also because they increasingly recognise the vested interests they have in the long-term future – often in the form of children, grandchildren and great grandchildren. Even self-confessed petrol head and climate change antagonist Jeremy Clarkson has been changing his tune recently, recognising the dangers we are facing – if that’s not a giant flashing sign of the changing times, I don’t know what is!
So overall, this short-term period of lagging performance has probably helped the industry mature and shake out flighty investors. Sustainable investing is here to stay, and that’s a great thing – but it is about aligning your money with your values, not trying to find the next sure-fire way to outperform.
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* Originally featured in Ben Seager-Scott’s City voice piece in the evening standard