European sustainable index fund flows surpass all others for first time

Inflows into self-proclaimed “sustainable” exchange traded funds overtook those into all other ETFs for the first time in Europe in the first quarter of the year.

Assets in passive funds tracking indices based on environmental, social and governance principles jumped from $59bn to $174bn last year, according to data from TrackInsight.

Flows accelerated still further in the first three months of this year, with the record $25.8bn taken in by funds in Europe exceeding the $22.3bn collected by non-ESG ETFs for the first time, according to data from Morningstar. As recently as 2019, these strategies accounted for just a sixth of new money heading into ETFs.

“There has been a significant increase in flows into ESG products in the last two quarters, and this is expected to continue, supported by new money and by a rotation from non-ESG investments into ESG alternatives,” said Jose Garcia-Zarate, associate director, passive strategies research at Morningstar.

The figures come days after the Biden administration pledged to halve US greenhouse gas emissions by 2030 at a virtual White House summit. Canada, Japan and South Korea also made new climate commitments, signalling growing global consensus on environmental policy — a core pillar of this investment strategy.

President Xi Jinping also pledged to “phase down” coal consumption in the five years from 2025, the first time China’s government has committed to reduce its use of the fossil fuel.

“A lot of investors, whether it’s by virtue of preference or regulatory pressures, are going into sustainable investing. ESG is becoming the new normal. We are at the beginning of this journey,” Garcia-Zarate said.

Sustainability-focused strategies have risen to account for more than 10 per cent of the ETF market in Europe for the first time, the Morningstar data show.   

The picture looks different in the US, which has lagged Europe on the sustainable investment agenda. Sustainable ETFs accounted for just $7.6bn, or 3.1 per cent, of the record $248bn that flowed into all index funds in the first quarter of the year.

However, ESG is starting to make headway there, with the BlackRock US Carbon Transition Readiness ETF breaking global records for first-day inflows for any ETF when it took in $1.25bn earlier this month.

Amin Rajan, founder of Create Research, a consultancy, said the strong performance of ESG index funds during the pandemic market sell-off last year meant demand would continue.

“Before then ESG was seen very much as a bull market luxury,” Rajan said. “[People worried] how they were likely to fare in a market correction, and that question was answered with ESG funds performing much better than anyone expected, including me. They have really stood the test of time.”

The investment strategy still has challenges, partly relating to the risk of exaggerated or false environmental promises, known as greenwashing. It also overlaps with mainstream investing; the ESG variant of the S&P 500, for instance, has the same five top holdings as the mainstream version — Apple, Microsoft, Amazon, Facebook and Alphabet. And while the average metric tonne of CO2 per $1m invested through this framework is 21 per cent lower, it is not zero.

“Are companies improving their carbon footprint? There is so much greenwashing. I don’t know if there are many governance improvements going on,” Rajan said.