Will ESG Investing Hold Up in Bear Market?

Since 2009, investing based on environmental, social, and corporate governance (ESG) principles has boomed, becoming a $35 trillion industry. But in May, U.S. sustainable funds reported an unusual monthly outflow of $3.5 billion, raising the question—will investors remain committed?

Rising interest rates and recession worries have fueled a bear market, slowing inflows into ESG accounts. They had dropped off before May, though they hadn’t entered outflow territory. ESG funds took in $7.5 billion in the first five months of 2022 compared to $35 billion during the previous period.

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"If we were to try to claim that demand for ESG funds is materially deteriorating, you would want to see that demand is sinking faster, and for an extended period of time, than the broader market," Alyssa Stankiewicz, Morningstar's associate director of sustainability research, told Reuters.

During the past five years, sustainable funds have outperformed a representative group of other funds by 1.4% annually, but they fell short of the broader market by almost 2% during the first half of 2022, according to Morningstar Direct.

Investors are responding to the fluctuations in all sorts of ways, according to various surveys. The Journal of Financial Planning and the Financial Planning Association reported in June that 28% of financial advisers planned to increase their use or recommendation of ESG funds over the next year, up from 24% in 2021. But 15% planned to decrease usage over the same period, compared with just 4% in 2021, the survey showed.

Also, an RBC Wealth Management survey of 976 investors found that financial performance and returns were a higher priority than ESG impact for nearly 50% of those questioned, an increase of about 8% from last year.

"They [ESG investors] tend to be less performance-focused than your traditional investor, so I think there’s a willingness to commit and stay with companies through periods of volatility," Peter Essele, head of portfolio management for investment adviser Commonwealth Financial Network, told Reuters.
Sometimes, periods of slow growth favor companies with steady growth prospects, including those in the ESG-friendly technology and healthcare sectors, according to Cheryl Smith, economist and portfolio manager at ESG investor Trillium Asset Management.

"We're looking at it as a source of outperformance, and that's something that I think more and more investors are starting to recognize," said Amber Fairbanks, portfolio manager at sustainable investment firm Mirova US.

And, market trends may ultimately help the portfolios of ESG funds in the coming months. Technology stocks, for example, have rallied since last month, presenting a potential boost to ESG funds if the activity continues.