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ESG accounts for 65% of all flows into European ETFs in 2022

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Exchange traded funds aligned with environmental, social and governance outcomes accounted for 65 per cent of all net inflows into European ETFs in 2022, even as ESG strategies underperformed.

The ESG ETFs gathered €51bn over the year out of total flows to European-domiciled ETFs of €78.4bn. The overall totals were down on 2021 when investors poured €160bn into European ETFs, but ESG’s share jumped significantly from the 51 per cent recorded then.

There is now €249bn in ESG-aligned ETFs in Europe, representing 18.8 per cent of total assets.

“In principle, this speaks of a long-term structural change,” said Jose Garcia-Zarate, associate director of passive fund research at Morningstar. He noted that 2022 was not a year to be investing in ESG for those purely focused on near-term returns. Instead a more sensible tactical approach might have been to focus on fossil fuel firms or weapons manufacturers. “I guess it tells us that investors are taking the long-term view,” he said.

Morningstar data show that “sustainable” large-cap equity ETFs in Europe have underperformed their traditional large-cap equity ETF counterparts over the 12 months to the end of December, but also on a three-year and five-year annualised measure.

European-domiciled sustainable large-cap ETFs have consistently underperformed

“There are still investments that make sense from a return perspective — energy and defence sectors spring to mind — but may not meet current ESG-titled portfolios,” said Hector McNeil, co-founder and chief executive of HANetf, a white-label ETF provider. “I suspect money managers will have to explain that [impact on returns] to their end investors if it results in underperformance,” he said.

The increasing relative popularity of ESG strategies in Europe is particularly eye-catching given that it has also coincided with a hard year in terms of ESG’s public image, particularly in relation to accusations of greenwashing.

In 2022, asset managers downgraded scores of “dark green” Article 9 ESG funds holding tens of billions of client money to their lighter green Article 8 counterparts under the EU’s sustainability classification.

Growing concerns over greenwashing in Europe have coincided with a strengthening anti-ESG movement, particularly in the US, against “woke capitalism”.

“The US is slower to adopt ESG because it has become a major political issue,” said Peter Sleep, senior portfolio manager at 7 Investment Management.

Garcia-Zarate said Morningstar analysis of the US market at the end of October revealed that while about 20 per cent of ETF holdings in Europe were ESG-related, the comparative figure in the US was only around 1 per cent.

Looking ahead, Sleep said that while concerns over greenwashing did not seem to have any effect on flows they had caught the attention of regulators.

“For instance, the UK regulator has recently brought out its proposed regulations which are explicitly to address the issues of greenwashing. If these regulations are enacted as they stand most of the ETFs we refer to today as ESG or socially responsible investing may lose their label,” he said.

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