Sustainable funds beat traditional funds in the first half of 2023, driven mainly by a rebound in growth stocks, according to a new sustainable reality report from the Morgan Stanley Institute for Sustainable Investing.
Investor demand also remained strong as sustainable funds’ assets under management (AUM) reached record levels.
The report revealed that the median return for sustainable funds in the first six months was 6.9% against its conventional peers’ 3.8%.
This was attributed to changing market conditions and investor sentiment, It said that a rapid rise in interest rates last year structurally benefitted value styles of investing, but the more stable market conditions of H1 2023 favoured sustainable funds’ more growth-oriented, long-term positioning, it said.
Longer duration in fixed income also helped contribute to sustainable funds’ robust performance, Morgan Stanley said.
“Our mid-year update shows the resilience of ESG funds with a return to outperformance after a challenging 2022,” said Jessica Alsford, Morgan Stanley’s chief sustainability officer and chief executive officer of the Institute.
She added, “Investors are increasingly turning to sustainable funds with sustainable AUM now at ~8% of total AUM globally.”
By asset class, sustainable equity funds was out in front with the strongest gains – a 10.9% median return. This was versus the 8% of their mainstream counterparts.
Fixed income’s showing was more muted, with sustainable funds generating a 3.8% median return compared with the traditional funds’ 2.2%.
The report showed that sustainable funds’ assets under management (AUM) continued to grow despite last year’s underperformance, with net positive first-half inflows of $57bn in H1. This was just over 2% of 2022 year-end AUM.
As a proportion of total AUM, sustainable funds’ reached record levels of 7.9% by the end of June.
Regionally, Europe continues to outpace other geographies in terms of sustainable AUM and fund counts. The region accounts for the bulk or 89% of total sustainable funds, compared to 10% in North America and less than 2% in all other regions.
By fund count, Europe is home to more than two-thirds of the world’s sustainable funds, followed by North America at 12% and Asia at 12%
The report also looked at the 1H 2023 performance and demand for Article 8 and 9 funds under the EU’s sustainable finance disclosures regulation (SFDR), which came into effect in 2021.
There are three main classifications under SFDR. An Article 6 classification does not have a sustainable investment objective. Article 8 promotes environmental or social characteristics, while Article 9 has a sustainable investment objective.
It noted that both slightly underperformed the European funds within Morningstar’s narrower sustainable definition but beat European traditional funds.
Morningstar defines a strategy as a “sustainable investment” if it is described as focusing on sustainability, impact, or ESG factors in its prospectus or other regulatory filings.
The report also noted that the SFDR was a driver behind the sharp rise of restriction screening in Europe, whereby investors try and limit exposure to certain issuers, products or activities based on their values or regulatory requirements.
More than 20% of total global AUM now uses at least one restriction screen, a surge from just 2% in 2019. Controversial weapons, thermal coal and tobacco are the most-used screens.
In Europe, almost 60% of AUM uses screens, compared to 8% in Asia and less than 2% in North America.
Looking ahead, the report said that if prevailing market conditions persist in the latter half of 2023, sustainable funds should continue to benefit, given their more growth-oriented, longer-term positioning.
However, a return to a market environment that favors value or shorter-term assets has the potential to impact future performance, as seen in 2022.
“Even so, sustainable funds’ AUM is likely to continue increasing, as inflows have largely weathered volatile market conditions and as investor demand for sustainable funds grows,” it added.
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