ESG ETFs See Continued Growth Despite H1 Inflow Slowdown  - ESG Investor (2024)

Europe dominates market for passive solutions, with greater investor focus on specific ESG objectives.

Across H1 2023 ESG exchange-traded funds (ETFs) assets have continued to grow, albeit at a slower pace than in previous year, with expectations for a “dynamic” market in the second half and beyond.

According to research and consulting firm ETFGI, global investment in all types of ETFs currently totals US$10.5 trillion, in terms of assets under management. The US accounts for around 70% of this figure.

While Europe only accounts for 16% of assets across all types of ETF, the region is where 66% of all ESG funds are domiciled.

ESG ETFs are “more of a European phenomenon” compared to the “typical ETF landscape”, said Deborah Fuhr, Managing Partner at ETFGI.

Fuhr said that one of the research and consulting firm’s recent key findings was that between the end of 2022 through the end of June assets invested in ESG ETFs globally had increased by 17.6%. In August last year, total assets invested in ESG ETFs and ETPs decreased by 3.1%, before rebounding with a 10.6% increase by the end of October.

At the end of June this year ESG ETF assets were worth US$457 billion, jumping from US$389 billion at the end of last year.

She also flagged that ESG ETFs have seen three months of consecutive net inflows.

“Regardless of the size of an investment, ETFs can be a useful tool for all types of investors,” Fuhr told ESG Investor.

A report by the Association for Financial Markets in Europe showed that the value of funds with an ESG mandate, including mutual funds and ETFs, totalled US$8.4 trillion as of Q2 2023. This marked an increase of 25.3% from the same period last year, but a 0.1% decrease from last quarter. This marginal quarterly decline was accompanied by net fund outflows, totalling US$26.3 billion during Q2.

Continued inflows

Released earlier this year, BNP Paribas Asset Management’s European ESG ETF Barometer survey found that investors expected the market to continue to expand in 2023, which it has, although potentially not to the degree some investors may have hoped.

More than 8 in 10 (81%) of investors said they expect ESG ETF assets under management to remain stable or further expand the next 12 months, with 96% of UK-based investors saying they expect stability or growth for these funds.

According to ETFGI, Europe’s largest asset manager Amundi saw US$4.8 billion of net new assets into its ESG ETFs. This was followed by the DWS-owned Xtrackers with US$4.2 billion and Blackrock’s iShares at US$3.3 billion.

In April, German asset manager DWS launched the largest-ever ETF to date in a passive fund with exposure to companies demonstrating climate transition leadership. The New York Stock Exchange-listed Xtrackers MSCI USA Climate Action Equity ETF began trading with US$2 billion of assets. DWS currently has 14 US-listed climate-related and ESG ETFs with combined assets of US$4.5 billion.

Morningstar places DWS second in the top 10 European sustainable fund providers by flows in Q2 with US$2.9 billion in net flows, driven by its two bestselling equity strategies – the Xtrackers MSCI AC World ESG Screened ETF and Xtrackers MSCI World ESG ETF. BlackRock, including iShares, topped the list with US$6.9 billion in net flows.

According to Morningstar’s Q2 2023 Direct European ETF Asset Flows Update, flows into European ESG strategies totalled close to €10 billion in the second quarter, marking only a slight slowdown from €10.7 billion in Q1. Flows into ESG products accounted for 35.5% of total ETF investments in the first half of 2023.

In 2021 and 2022 more than half of the flows into the European ETF market went to ESG products, Morningstar reported. However, in H1 2023 these flows have fallen to approximately 30%.

ETF advantages

Despite this slowdown, there are still advantages offered by ETFs that are proving attractive to investors, analysts said. Morningstar previously noted that ETFs offered the benefits of lower fees and advancements and innovations in indexing, as well as citing “lacklustre performance” by rivals which saw passive ESG funds inflows outweigh their active counterparts.

These sentiments were echoed by Jose Garcia-Zarate, Passive Strategies Associate Director at Morningstar, who said that it “doesn’t really matter whether you are ESG conscious or not” given the key advantages of low costs, transparency, ease of use and access to different markets offered by sustainable ETFs.

He added that ETF industry is “very dynamic in terms of product evolution, creation and generation”, with fund launches by ETF providers potentially offering an “interesting opportunity for anyone considering adding ESG”.

Garcia-Zarate highlighted that the industry is “very aware of what’s in and out with investors”, and that ETF providers are “always on the lookout to create products that meet existing trends”.

“Even though we’ve seen a slowdown in flows, it doesn’t necessarily equate to investors being not interested in ESG propositions anymore,” he added.

Financial technology firm Trackinsight’s Global ETF Survey 2023 released earlier this year said that investors are expanding their use of ETFs, underlining that these funds offer the opportunity to “build better-suited strategies for financial markets characterised by significant uncertainty”.

A European “phenomenon”

Brown Brothers Harriman’s 2023 Global ETF Survey found that 43% of US, 50% of European, and 62% of Greater China’s investors plan to add ESG exposures this year. Across the three regions, only 9% of respondents said they plan to decrease their ESG investment allocation.

Fuhr said that to date there had been greater focus on the environmental themes in sustainable ETFs, while the social and governance prove “tougher for investors to get their heads around”. She added this may be due to social and governance largely “lacking good data”, with privacy regulations in Europe playing a factor.

Garcia-Zarate agreed that product development had generally concentrated on the environment, building out from broader ESG products that provide access to major indexes, with a green tilt or tint offered by exclusion or methodology.

“People are becoming more specific on the ESG objectives that they want to target,” he said, adding that “more people are focusing on specific things such as decarbonisation and the net zero transition.”

Product development by fund managers is being supported by innovation by index providers.

Deutsche Boerse Group–owned Qontigo and ISS ESG recently collaborated to create the ISS STOXX Biodiversity indexes. Qontigo said the indexes’ overall objective is to allocate capital to companies that minimise their biodiversity footprint and support the world’s natural capital.

Earlier this year, FTSE Russell launched the FTSE UK ESG Risk-Adjusted Index Series. The index combines ESG scores, carbon emissions metrics, including intensity of reserves, and exclusions in a broad ESG index series. The firm already had a climate-dedicated index series and an exclusions-focused series, but FTSE Russell said the product aimed to “fill the gap” between the two.

Fuhr said that European investors have greater appetite ESG than the US, as well as regulations and regulators “encouraging investment into ETFs in a way that you don’t see in the US”.

“In relative terms this is a trend that is driven primarily by European investors,” Garcia-Zarate said. “This is definitely a European phenomenon, and not just for ETFs but for ESG investment in general”.

“Even before the backlash, ESG was never really at the forefront of the US investors mind quite frankly,” he added.

Despite the limited success of ESG ETFs in the US, anti-ESG funds have fared no better. 2nd Vote Funds, an asset manager and index provider, said it plans to liquidate the two ETFs it created in 2020 for conservative investors. Analysis by Morningstar also showed that following a peak of US$376 million in Q3 2022, anti-ESG funds have seen inflows slow significantly.