The Responsible Investor

ESG Investing: A Year in Review

After nearly a decade of increased popularity, Environmental Social and Governance (ESG) funds faced challenges in 2023. The third quarter of 2023 was the fourth consecutive quarter of outflows in ESG funds.[1] According to Morningstar Direct, Manager Research, investors pulled $2.7 billion from U.S. sustainable funds in 2023′s third quarter, for a total of $14.2 billion over the past year. The reduction in demand affected sustainable funds more than conventional funds.

Why are sustainability funds shrinking? Here are a few reasons that may explain why this has been the case.

Different Economic Backdrop

In general, the stock market and interest rates have an inverse relationship. Currently, we are in an economic environment with the highest interest rates we’ve seen here in the United States since the Great Financial Crisis of 2008. Up until 2022, before the Fed started hiking interest rates, we were in a near 0% interest rate environment for over a decade. Low interest rates are typically good for Growth stocks since they can borrow at lower interest rates to fuel the growth of their profits.[2] Growth stocks handedly outperformed Value stocks in the 2010 decade, with the Russell 1000 Growth Index gaining 260% during that time, compared to just 189% for the Russell 1000 Value Index.[3] Growth Stocks typically have higher ESG scores, which means that many ESG funds benefited from the outperformance of Growth Stocks during that decade.

In 2022, there was a sharp reversal due to higher interest rates, and Value stocks vastly outperformed Growth stocks in that year. Fund flows typically follow investment strategies that are doing relatively well, which may be a reason why investors flocked to ESG funds during the 2010s and why they have been pulling money from those funds over the past two years. 

Current events over the past few years may also explain some of the ESG fund underperformance. Industries that are typically excluded from ESG funds, such as weapons, oil and gas, have performed relatively well recently. After the Covid pandemic, there was a large global demand for oil which coincided with record profits for big oil companies.[4] Geopolitical risks seem to be as high as ever with wars going on in Ukraine and Gaza. These risks provide an opportunity for weapons producers to increase their profits.


ESG has been a hot-button topic as both parties ramp up campaign promises towards the 2024 presidential election in the United States. ESG has faced backlash from many conservative politicians for implementing “woke” objectives by putting investment returns as a secondary priority relative to advancing various social causes. They also object to the ESG scoring system which they see as subjective and inaccurate due to practices such as greenwashing. So far, there have been 18 states that have adopted some form of anti-ESG legislation.[5]

Greenwashing is when a company makes false or misleading claims about their positive environmental impact. They may use vague or general language in their marketing to appear more eco-friendly with no verifiable evidence that they are more environmentally sustainable. One of the more famous examples of greenwashing is the case of Volkswagen back in 2015. VW was touting eco-friendly cars that emitted lower overall emissions than standard vehicles. However, the actual situation was that the cars were fitted with an intentionally defective device and were admitting 40 times the allowed limit of pollutants.[6]

Greenwashing occurs in the investment management industry as well. In 2022, BNY Mellon had to pay a $1.5 million fine after the SEC had found that the firm was misstating its ESG investment policies for funds that it was managing.[7] Basically, the firm was saying in marketing material that a fund was an ESG fund, however specific Environment, Social, and Governance criteria was not being applied in the underlying investment strategy. BNY Mellon is not alone, as there have been 148 cases of greenwashing just in the banking and financial services industry From October 2022 through September 2023.[8]

In September 2023, the Securities and Exchange Commission adopted a new rule that aims to curb “greenwashing” in the investment industry. The SEC’s new rule requires that 80% of a fund’s portfolio matches the name of the fund.[9] The goal is to crack down on the number of funds that were looking to capitalize on the popularity and growth of ESG investing, but not actually following through with implementing ESG as part of the investment decision making process. A growing number of funds are removing ESG-related terms from their names to comply with this new rule and there are fewer new ESG funds being launched.

Strong ESG demand outside of the U.S.

While ESG fund flows have declined over the past two years here in the U.S., European ESG funds continue to take in new money. In the third quarter this year, European ESG funds gathered over $15 billion of new money, which accounted for more than two thirds of the overall fund flows for European funds.[10] Asia (excluding) Japan reported $2 billion of net inflows into sustainable funds in Q3 as well.[11]

Europe makes up most of the sustainable fund landscape, with 85% of global sustainable fund assets. It is also considered the most developed and diverse ESG market. The United States comes in second, housing 11% of global sustainable fund assets at the end of September 2023. Globally, there remains over 7,600 ESG funds with $2.7 trillion in assets. The number of new sustainability funds hitting the market is starting to slow as well. In Q2 of 2023, 154 new sustainability funds launched globally. In Q3, that number dropped to 102.[12]


1. Stankiewicz, A. (October 23, 2923). Sustainable funds hit by weaker demand in Q3 2023.
2.Armour, B. (October 24, 2023). Where to invest amid higher interest rates.
3. Lewis, A. (December 24, 2019). After a big decade for growth investing and the ‘FANG’ stocks, some are considering a change.
4. Shanks, A. & Stafford, K. ESG: weathering the market headwinds. (February 16, 2023). Schroeders.
5. Dial, L. C., Crowley, D. F. C., McCoy, J. R., Chainey, B. R. 2023 ESG state legislation wrap up. (July 25, 2023). K & L Gates Hub.
6. Robinson, D. (July 17, 2022). 10 companies called out for greenwashing.
7. Johnson, K. (May 23, 2022). BNY Mellon unit pays $1.5 million over ESG fund misstatements, SEC says. Reuters.
8. Haill, O. (October 23, 2023). More banks and finance companies caught out greenwashing, research finds.
9. Gillison, D. & Price, M. (September 20, 2023). US SEC cracks down on funds “greenwashing” with new investment requirement.
10. Morning Star Research. (October 25, 2023). Global Sustainable Fund Flows: Q3 2023 in Review. Morningstar.
11. Miller, L. (October 25, 2023). Asia sustainable funds see higher inflows in Q3 despite global declines. ESG Clarity.
12. Ibid. 



Learn more about Derek Van Calligan


Hello! I’m Derek, a wealth advisor and director of investment research at Allodium Investment Consultants, located in Minneapolis, MN. I am passionate about helping individuals and families build holistic financial plans to help them reach their goals. When I’m not helping our clients make investment decisions, I enjoy spending time in the mountains in Colorado—skiing, fishing and hunting with my wife, Kelly, and my dog, Hank. I am also an active church member and volunteer at Big Brothers Big Sisters and Junior Achievement.


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