Morgan Stanley ESG ETFs Face Uncertain Future

CFRA Research says ESG is at a crossroad.

Morgan Stanley may have an uncertain future to contend with as the firm reenters the world of exchange-traded funds, analysts at CFRA Research say.  

Last month, a filing from the investment banking giant indicated it would be reentering the ETF industry for the first time in 25 years with six new ESG funds. The proposed ETFs consist of four equity-focused index funds, one equity ETF and one active bond ETF.  

The company’s foray into the ESG space comes at a precarious time for both ESG and equity-focused funds. Last year, investors flocked to the socially conscious investment vehicles, spurring ETF issuers to launch new ESG funds. More than 60% of the 252 ESG-focused, U.S.-listed ETFs were launched after 2020, a Sept. 13 note from CFRA Research said.  

Headwinds Ahead 

But the considerable excitement for ESG has since decreased, with inflows into these types of funds plummeting in recent months.  

Source: Strategas Securities  ​

It's not just ESG funds that have taken a hit. ETF.com data shows the industry has seen net outflows for the first time in over two months in the past two weeks. Last week, equity-focused ETFs alone shed $3.7 billion. Year to date, the S&P 500 is down more than 17.7%.  

The ESG ETF industry faces another notable headwind—the lack of a unifying issue or definition, according to the Head of ETF Data and Analytics at CFRA Research Aniket Ullal.  

“The ESG space still has fundamental definitional and philosophical issues to be resolved. For example, does ESG mean excluding certain high carbon sectors such as oil & gas entirely, or selecting the “best of the worst” from these sectors,” Ullal said in the note earlier this week. “These are not easy choices, since it may result in tradeoffs between fidelity to ESG principles and performance, such as in 2022, with energy stocks having performed well.”  

However, Ullal added that increasing momentum on the Securities and Exchange Commission’s proposed rules for ESG funds could encourage more investment into the ESG ETF industry. In May of this year, the agency issued two proposals that would require more disclosures from funds claiming to invest in companies that adhere to environmental, social and governance factors.  

“With less than 2% of U.S. equity ETF assets as of September 2022, the ESG industry is at an interesting crossroads,” Ullal said in the note. “If these ETF product choices do not adequately meet their needs, investors may opt for other routes, such as separately managed accounts or direct indexing. The launch of Morgan Stanley’s ESG ETFs will be an interesting inflection point on this journey.” 

Contact Shubham Saharan at [email protected]