ESG Funds Could Face 'Tons of Closures'

The label is spooking issuers and has investors running for the hills.

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Reviewed by: Lisa Barr
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Edited by: Sean Allocca

Environmental, social and governance funds may be facing a watershed moment as billions of dollars in assets have cleared out of the segment this year alone.

Once-bullish assets managers are increasingly shying away from the politically charged investment strategy and are stripping the terminology from exchange-traded funds. Some analysts are even predicting a major course correction. 

“The demand for ESG ETFs was so grossly overestimated,” said Eric Balchunas, senior ETF analyst at Bloomberg Intelligence. “There’s going to be tons of closures coming up.”

Political backlash and trailing returns have investors running for the hills. Domestic ESG-labeled ETFs have collectively lost $5.8 billion year to date, Bloomberg data shows, on top of the $2.1 billion lost in the fourth quarter of 2022.  

For comparison, billions of dollars poured into the industry just two years ago, with ESG funds hauling in nearly $32 billion in 2021, Strategas data shows. ESG fund launches also ballooned, as 209 ESG-listed ETFs with $90 billion in assets hit U.S.-listed markets in the last two decades, according to etf.com data.

 

Source: Strategas Securities  

 

Among the biggest losers has been the largest ESG index fund, the iShares ESG Aware MSCI USA ETF (ESGU), which has shed nearly $6.3 billion year to date, and recently posted its largest one-day loss of $4 billion, etf.com data shows. BlackRock declined to comment about the movement. 

The fund reflects a broader, bubbling anti-ESG sentiment.

“ESG has gathered a lot of baggage, is the word I use,” Balchunas said. “It's political baggage, return baggage. It's just become a political football of a term.”

Political Backlash  

The criticism of ESG-focus investment strategy and methodology did not emerge this year, but it has been simmering in recent months.

Several ETF providers have even gone so far as to drop the ESG label. In February, VictoryShares ETFs, which manage almost $8 billion across 25 U.S.-listed products, removed “ESG” from two of their bond ETFs.

In August, Idaho-based Inspire ETFs also shed “ESG” from eight of their fund titles. 

“Due to the escalation of leftist intolerance and rancor in recent months, we no longer desire to identify our investment approach as being part of the ESG category,” said Inspire Investing CEO Robert Netzly in a company statement announcing the changes. 

It’s not only issuers citing concerns about ESG, Republican-led states have pulled out more than $1 billion from BlackRock, parent of the world’s largest ETF issuer and ESGU’s issuer, iShares.

On the other side of the aisle, Democrats have criticized the firm for not being ESG enough. In September, New York City Comptroller Brad Lander slammed the firm for the “fundamental contradiction between BlackRock’s statements and actions.”

Evolving ESG Tactics 

Asset managers are also adjusting their stances on ESG seemingly in reaction to the changing public sentiment. BlackRock CEO Larry Fink has tempered his usual optimistic tone on ESG investing, reframing the issue as investment opportunities as opposed to socially conscious investments in his latest letter to investors.

Vanguard, the second largest ETF issuer, pulled out of the net zero climate effort in December, an investment industry initiative to tackle climate change. 

In another telling example, Hypatia Capital launched in January the Hypatia Women CEO ETF (WCEO), bringing a fund to market that specifically focuses on the performance of U.S. public companies with female CEOs. While gender diversity on boards and in executive ranks is a high-profile governance issue, neither of the funds were tagged with an ESG label.

“Now, we believe that ESG in general is an overlay concept,” said Patricia Lizarraga, managing partner of Hypatia Capital, during an Exchange Traded Fridays podcast in March. “We are not picking our stocks for E, for S or for G. We are saying that women CEOs outperform.” 

To be sure, ESG remains a focus for firms as they launch funds. More than a quarter of respondents said they would be most keen to launch a fund with “broad consideration of ESG issues” as compared to any other theme, according to a recent HSBC ESG Sentiment Survey. More than a third of the 422 individuals surveyed also indicated that ESG would be mainstream in a decade.

In the first half of 2022, the number of ESG-labeled mutual funds and ETFs jumped 23%, according to a December report by Cerulli Associates.

“Recent political pressure has not deterred most firms,” said Michele Giuditta, Cerulli’s director of institutional practice, in an interview with etf.com in December. “Managers are committed to ESG, and I don’t think this is going to change their plans.”

Underperformance Weighs on Investors  

The underperformance of ESG has also added to the segment’s woes. The funds, which can charge a heftier expense ratio but carry many of the same investments as benchmark index counterparts, is contributing to the problem, said Mark Neuman, CIO of Constrained Capital.

“What happens is, once returns go sour, people start to take notice,” he said in an interview with etf.com. “Guaranteeing promises that everyone wins and nobody loses and everyone does better— that sounds like fantasyland, not like reality.”

Funds like ESGU and the second largest ESG index fund, the Vanguard ESG US Stock ETF (ESGV), have slightly underperformed the benchmark SPDR S&P 500 ETF Trust (SPY) in the trailing 30 days. The funds have dipped 0.8% and 0.7%, respectively, trailing SPY, which has slumped just 0.2% during the same period.

While the difference between the two may seem minimal, those lagging returns are weighing on investors hunting for returns amid whipsawing markets and bank runs, Neuman said.

And while some investors may choose to keep or add ESG products to their holdings in the future, they may not be the core of most portfolios moving forward, said Bloomberg’s Balchunas.

“There'll be a niche,” he said. “ESG ETFs will exist, but they’ll be fringe.” 

 

Contact Shubham Saharan at [email protected]        

Shubham Saharan is a markets reporter at etf.com. Before joining the company, she reported for Bloomberg and the Financial Times. Saharan is a graduate of Barnard College of Columbia University.