Shifts in Investor Sentiment
One major factor contributing to this shift in investor sentiment is the rhetoric and policies of former U.S. President Trump, which have been perceived as anti-ESG (Environmental, Social, and Governance) and anti-DEI (Diversity, Equity, and Inclusion). These stances may have deepened negative perceptions regarding sustainable investments. Additionally, the relatively underwhelming performance of sustainable funds compared to traditional investments may have fueled dissatisfaction among investors.
Cautious Asset Managers
The U.S. administration’s stance against ESG initiatives has prompted asset managers to adopt a more cautious approach towards developing new products, as they fear navigating a potentially litigious environment. Furthermore, these managers are contending with an evolving regulatory landscape, where new regulations regarding fund naming and marketing practices are being implemented. In recent years, firms such as DWS in Europe, as well as Invesco and Goldman Sachs in the U.S., have faced penalties for greenwashing, which refers to misleading claims about a fund’s environmental performance.
Significant Outflows
According to Morningstar’s data for the first quarter of 2025, U.S. sustainable funds faced redemptions totaling $8.6 billion, with the U.S. market accounting for approximately 70% of this figure, or $6.1 billion. This marks the tenth consecutive quarter of net outflows for the U.S. sustainable funds market. In Europe, while the outflows were more modest at $1.2 billion, this was nonetheless the first instance of net outflows since Morningstar began tracking sustainable investment funds in 2018.
Geopolitical Factors at Play
Morningstar attributes the decline in sustainable investments to an increasingly complex geopolitical climate, which has led to a diminished focus on sustainability issues in Europe, including climate objectives. The anti-ESG policies initiated by Trump have had a ripple effect, creating uncertainty among European investors regarding global sustainability alignment. Compounding this hesitation are evolving European regulatory frameworks and ongoing concerns about the performance of sectors like clean energy, which have been under pressure.
Performance Disappointments
The sustainable funds market, which encompasses open-ended funds and exchange-traded funds, held assets worth $3.16 trillion at the end of March, slightly down from $3.18 trillion in Q1 2024. Europe dominates with an 84% share, while the U.S. accounts for only 10%. The returns from sustainable funds, which incorporate ESG factors and aim for sustainable development goals, have lagged since around 2022. Elston Consulting notes that the peak period for ESG investing was during the COVID-19 pandemic when these funds saw record inflows and outperformed traditional indexes.
Unfavorable Economic Conditions
However, persistent inflation and rising geopolitical tensions have negatively impacted sustainable fund performance. Elston highlights that these ESG-focused funds generally avoid fossil fuel companies and sectors that can mitigate inflation risks, such as commodities and energy. The ongoing conflict in Ukraine has further boosted defense industries, which are excluded from sustainable investment criteria. The disparity in performance between ESG and traditional equity investments has led to a reassessment of the supposed long-term advantages associated with sustainable investing.
Decline in New Fund Launches
Morningstar reports a notable decline in the launch of new funds in recent quarters, indicating a “normalization” of product development after a period of rapid growth from 2020 to 2022. In the first quarter of 2025, only 54 new funds were introduced globally, a decrease from 105 in the previous quarter. Asset managers are now exercising caution in developing new ESG and sustainable strategies due to fears of greenwashing allegations and regulatory uncertainties.
Name Changes Reflect Market Trends
There was a marked increase in the use of ESG-related terminology in fund names between 2019 and 2022, but this trend has shifted recently. In the first quarter of 2025, around 335 funds with ESG terms in their titles underwent rebranding, with 206 changing specific ESG terms and 116 dropping them entirely. Morningstar estimates that over 640 European funds have rebranded since this trend began. The most frequently adopted new descriptor has been “screened,” while contentious terms like “selected,” “committed,” “tilted,” and “optimized” are being phased out.
Looking Ahead
The path forward for investors in sustainable funds is complex, prompting some to reconsider their allocation strategies. Although younger investors still express a desire to invest sustainably, there is a pressing need to clearly define their objectives and return expectations. A report from the Cambridge Institute for Sustainability Leadership highlights the persistent financing gap for climate and sustainability goals, emphasizing the potential to unlock $10 trillion in investment opportunities. However, the current financial system remains inadequately incentivized to prioritize sustainability, perpetuating a market failure that favors economically harmful activities over sustainable alternatives.
Trends in Greenwashing
RepRisk, which tracks reputational risk data, notes a decrease in overall greenwashing incidents in 2024 for the first time in six years, yet high-risk cases surged by over 30%. The severity of these incidents is evaluated based on their consequences, impact, and the intent behind them, underscoring the ongoing challenges in maintaining transparency and integrity in sustainable investing.
