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UK investors pulled money from so-called responsible funds at a record pace as the market adjusted to the view that rates would stay higher for longer and ESG lost its luster in a more volatile market.
Responsible investment funds recorded a record outflow of £544m in September, meaning investors have withdrawn more than £1bn so far in 2023, figures from the Investment Association show.
Responsible funds, which take environmental, social and governance factors into account in investment decisions, saw huge inflows between 2018 and 2021 following a wave of enthusiasm for thematic investing and ESG.
These funds performed well before and during the coronavirus crisis as they often focused on high-growth stocks in the developed world and avoided the energy and travel companies that were hit hard by the coronavirus restrictions.
But since the end of pandemic restrictions, they have struggled as growth companies were hit by rising interest rates, energy stocks soared and ESG investing in the US faced a political backlash. Analysts at Deutsche Bank attributed Europe’s underperforming ESG performance to “rising interest rates and the energy crisis.”
Data collected by Jefferies analysts shows that a lower percentage of ESG-labeled funds than non-ESG-labeled funds outside the US have outperformed their benchmarks as of 2021.
Analysts also suggested that the UK cost of living crisis was putting pressure on DIY investors, who withdrew a total of around £1.4 billion from funds in September – the biggest monthly outflow in 2023.
“Investors remain under pressure from inflationary pressures and the cost of living as net inflows into funds decline in the second quarter,” said IA chief executive Chris Cummings.
Elsewhere, investment continued to flow from money market and fixed income funds, with more than £300 million withdrawn in September. UK government bonds had an inflow of £237 million, while investors bought more than £200 million worth of corporate bonds.
UK equity funds remained the worst hit sector in terms of outflows, with UK corporate funds recording outflows of almost £900 million in September.
Other analysts insisted that even if recent statistics show an outflow, British investors will punish companies that fail to adhere to responsible standards.
“ESG-related factors are a priority for Hargreaves Lansdown investors when making investment decisions,” said Emma Wall, head of investment analysis and research at the platform.
“Deforestation and corruption are big no-nos for inclusion in the portfolio, and 70 percent of our investors consider climate change ‘extremely’ or ‘very’ important when making investment decisions. The message to companies is clear: transparency, ethical behavior and good governance practices are essential to attracting and retaining investors.”
Deutsche Bank analysts said the question of whether responsible investments performed better had yet to be resolved. “The debate over whether sustainable investments outperform non-sustainable investments in terms of returns remains uncertain and likely dependent on selected time periods and subject to exposure nuances,” they wrote in a July note.
“Yet they can be an attractive asset in portfolios if they provide a diversification benefit by decoupling from non-sustainable investments.”