In 2023, US sustainability funds experienced their worst year on record, with Morningstar reporting significant net outflows, as quoted on a Yahoo Finance article. The fourth quarter alone, investors withdrew $5 billion from sustainable open-end and ETFs.

This marked the fifth straight quarter of net outflows from sustainable funds. Throughout the year, a total of $13 billion was pulled from US sustainable funds, overshadowing positive flows in Europe and dragging down the global market.

This downturn, according to Alyssa Stankiewicz, Morningstar's associate director of sustainability research, was largely caused by macroeconomic factors such as global supply constraints, geopolitical tensions, and high interest rates. Plus, political scrutiny and regulatory ambiguity surrounding "greenwashing" contributed to a lack of investor confidence, the report indicated.

Challenges and Changes in Sustainable Investing Landscape

Despite the recent setbacks, US sustainable funds had seen significant growth in preceding years. However, the total amount invested in these funds declined by 12% from its peak in 2021, reaching $323 billion by the end of 2023. Stankiewicz noted that the surge in inflows witnessed between 2019 and 2021 did not translate into a wholesale retreat by investors, suggesting a more nuanced landscape.

Impact of Specific Funds and Preferences

One notable instance contributing to the outflows was the iShares ESG Aware MSCI USA ETF ESGU, which saw a withdrawal of $9.29 billion in 2023 following a shift in BlackRock's target-allocation ETF portfolios.

Goldman Sachs, an ETF provider with $30.6 billion across 41 ETFs, closed a $7.64 million climate-focused equity ETF two years post-launch, amidst increased regulatory oversight and conservative political opposition to ESG funds. Another popular ETF iShares ESG MSCI USA Leaders ETF SUSL saw 2.27 billion of outflow.

Passive funds remained more popular among sustainable investors compared to active ones, with actively managed funds causing the majority of outflows.

Performance Challenges and the ESG Argument

One of the primary reasons for investor disengagement was the underperformance of sustainable funds compared to their traditional counterparts. While returns improved from the lows of 2022, sustainable equity funds still lagged behind, with the median sustainable large-blend equity fund gaining 20.8% in 2023 compared to a 23.9% gain for all funds.

This underperformance challenged the core argument of ESG investing, which posits that investing in socially responsible companies yields better long-term returns.