ESG Investments Face Financial Hurdles

Authored by Felicity Bradstock via OilPrice.com,

• Investments in ESG, popularized in 2020 and 2021, are seeing disappointing returns, causing concern among financial experts.

• Recent trends show withdrawals from sustainable funds, with companies like Blackrock and State Street Corp. retreating from certain ESG ventures.

• Despite the challenges, some firms are re-strategizing, launching specific ESG products in hopes of better financial outcomes.

After several years of enthusiasm around environmental, social, and governance (ESG) investment, some financial experts are becoming increasingly pessimistic about the return on investment. There was a great deal of hype around sustainable or ESG investment in 2020 and 2021, as governments worldwide showed great support for a global green transition. Investment companies quickly labelled many of their funds as sustainable, as well as creating new ESG funds, to attract companies looking to “go green”.

However, a poor return on investment over the last couple of years has made many financial experts wary of continuing to invest in these types of funds, as they are unwilling to take the wait-and-see approach. 

ESG has gained greater attention in recent years, as both governments and consumers encourage companies to improve their ESG practices. This has been further accelerated in the U.S. following the introduction of the Inflation Reduction Act (IRA) climate policy last year, which provides financial incentives and tax breaks to companies that invest in green energy and technology. Consumers are increasingly expecting companies to improve their ESG practices in line with social norms and expectations, with many shopping around for the most socially responsible options on the market. Government aims to decarbonise and the potential introduction of carbon taxes in some countries have also encouraged greater investment in ESG. 

However, ESG investments that have gone to the clean energy and technology industries are seeing less of a return on investment than was previously hoped. Many renewable energy projects require huge amounts of investment to improve and become more efficient, but it could take years to make a breakthrough that will have a meaningful impact on wind, solar or other green energy operations.

Meanwhile, more and more funding is being pumped into the sector as investors remain in wait-and-see mode.

Now, certain fund managers have taken a step back on their ESG pledges. The Vice Chairman of S&P Global, Dan Yergin, stated

 “If you’re in a money management business, you do need returns.” Yergin explained,

“And we’ve seen that with more North American funds that, yes, we want to do energy transition, we want to do ESG. But we actually need returns as well. And that has shifted — the attitude — there’s kind of a more realism.” 

In the second quarter of 2023, investors retracted $635 million from U.S. sustainable funds, according to a Morningstar report. And, over the past year, a total of $11.4 billion has been withdrawn from these funds. Some investment companies appear to be withdrawing from certain sustainable funds altogether. For example, in September, Blackrock told regulators that it planned to close a pair of sustainable emerging-market bond funds with total assets of around $55 million. Companies such as State Street Corp., Columbia Threadneedle Investments, Janus Henderson Group Plc and Hartford Funds Management Group Inc. have all pulled money out of their ESG funds this year. 

By June this year, there were a reported 656 sustainable funds in the U.S., lower than previous years, as the amount of money withdrawn for ESG in the first half of 2023 has been higher than the previous three years combined. There was initially a lot of hype around sustainable or ESG funds in 2020 and 2021 after governments and the international community strongly pushed the idea of a global green transition. Fund managers quickly labelled many of their funds as sustainable, as well as opened new funds. But after two or three years of heavy investment, many are disappointed by the poor returns they are seeing. 

There is nothing simple about investing in renewable energy, with the costs of several green energy projects increasing due to supply chain disruptions and the increasing price of metals and minerals. For example, the costs of offshore wind have risen 40 percent over the last year, with many wind energy companies facing severe challenges when it comes to profits. And while the global investment in clean energy and tech reached around $1.3 trillion in 2022, the International Renewable Energy Agency stated that annual investments must grow fourfold if we are to achieve a maximum global temperature increase of 1.5oC. 

Although some fund managers are moving away from ESG investments, others are simply re-strategising when it comes to sustainable funds. Many companies are closing products that failed to attract the anticipated interest levels and are launching new, more specific products to encourage further investment in an uncertain market. This can be seen through BlackRock’s launch of two broad ESG exchange-traded funds (ETF) in 2023, an environmental solutions ETF with around $3.7 million and a sustainable global equity mutual fund with around $10 million. 

While the outlook for ESG and sustainable funds looks less optimistic than during the post-pandemic economic rebound, investment companies are not moving away from these types of funds entirely. As investments in ESG become more commonplace, investment companies will take lessons learned to launch specific new funds, aiming for a greater return on investments, to encourage companies to continue investing in green energy and related technologies.