Green Fatigue: The Declining Popularity in ESG Investing

Despite the undeniable significance of environmental, social, and governance (ESG) factors in both business practices and personal consumption, investor dollars are not drumming to the same tune. ESG and sustainable investing (used interchangeably in this article) has taken a back seat and recently experienced a decline in momentum.

In 2022, almost one in five dollars in the Australian ETF ecosystem was directed towards ESG. However, the appeal has now dwindled to its lowest point in six years, with ESG net flows making up only 5% of the total ETF net flows (refer to graph below).

As ESG flow momentum declines globally, regions like Europe and Australia have still been able to maintain positive numbers. In Australia, over $760 million flowed into ESG ETFs in 2023. However, other nations, including the US, have been shunning ESG ETFs, leading to billions of dollars in net outflows in 2023.1 There has also been a ramp up in the number of closures of ESG funds in the US while launches have slowed down.

With the decline in ESG momentum, some may ponder if it was merely a passing trend that peaked during the Covid-19 pandemic. Given the cyclical nature of trends, it seems ESG has handed the baton to the next hot topic in 2023—artificial intelligence (AI). For example, the frequency of BlackRock CEO Larry Fink’s references to sustainability, climate and ESG in his yearly shareholder letter has declined since reaching its highest point in 2020.2

However, perhaps ESG investing is not just a “fad” but more a function of the cyclical economic nature of markets. Matt Levine from Bloomberg wrote an interesting article on ESG being a low interest rate phenomenon. He argued that low discount rates increased the value of longer duration profits and growth, a characteristic often found in ESG-related companies, as companies are targeting net zero emissions by 2050. However, the landscape shifted in 2022 and 2023 with a surge in interest rates, leading to a prioritisation of assessing the value of today’s profits over future profits – an elementary principle of the discounted cash flow model.

It is not just investors who are re-thinking their ESG allocations. Companies are trying to balance the long-term necessity of ESG goals while also focusing on shorter-term financial returns. Some businesses have reduced their ESG workforce, with devoting more resources way from ESG to other focus areas.3  Some of the leading global asset managers have retreated from environmental pledges, taking a back step, and withdrawing from climate change industry initiatives.4

ESG investing is not necessarily dead though but has simply lost steam. Perhaps it got too intertwined with politics, and as the saying goes investors may have been better off removing politics from their portfolio. It could be that investors have been experiencing fatigue from political polarisation. The limited enthusiasm for ESG ETFs mirrors this sentiment.

Despite the poor sentiment in 2023, the performance of ESG funds have been solid. The average Australian share index-ESG strategy was up 13.2% compared to the broader share market which was up 12%.5 Longer term studies have also shown that investors do not need to compromise returns by investing in a sustainable way.6

ESG investing is likely here to stay and not going anywhere. The recent fatigue is merely just a reallocation of capital and a slowing of momentum. Despite this capital allocation shift, creating a more sustainable planet is still front of mind for global economies, highlighted at the recent United Nations Convention on Climate Change in December 2023 (COP28), which aimed to signal the beginning of the end of the fossil fuel era as it transitions towards climate friendly solutions.7

There are over 50 ETFs available on the Australian market to provide investors access to sustainable securities. The market for ESG ETFs in Australia is now worth over $11 billion and growing at a ten-year compound annual growth rate of 70% per year compared to the broader market of 34% per year (refer to graph below).

ETFs have democratised sustainable investing, enabling investors choice and accessibility. Certain ETFs offer broad exposure to the shares exhibiting high ESG ratings, while other ETFs are more specific in their focus, targeting ESG-related themes. Investors can choose to establish the core of their portfolios with broad ESG ETFs or enhance their existing portfolios by incorporating ESG-related thematics.

This may involve adding specific exposures like carbon credits through the Global X Global Carbon ETF (Synthetic) (ASX: GCO2) or green metal miners through the Global X Green Metal Miners ETF (ASX: GMTL). An alternative approach could be adding decarbonisation energy themes to portfolios such as the Global X Uranium ETF (ASX: ATOM), Global X Hydrogen ETF (ASX: HGEN) or the Global X Copper Miners ETF (ASX: WIRE).

While fatigue in ESG investing is evident, it might just be a moment for this market to catch its breath, signalling that ESG has not vanished but merely evolving in response to changing dynamics and investor demands.