10.02.25 09:34:41

“Doing good or just marketing? For ESG funds, it's all over again”

After the Paris Climate Conference in 2015, sustainability funds increasingly became a sales hit for the fund industry and its annex companies. Investors will be left behind from 2022. Ali Masarwah, fund analyst and managing director of the financial services provider envestor, explains why a reset is now needed for sustainability investments.


10 February 2025 FRANKFURT (envestor): The public became increasingly aware of sustainability funds in 2015, the year of the Paris Climate Conference. The climate agreement adopted there set ambitious targets: Global warming was to be limited to well below 2°C, preferably to 1.5°C compared to pre-industrial levels. In addition, the aim was to achieve greenhouse gas neutrality in the second half of the 21st century. Another key point was the provision of financial resources for climate protection and adaptation to climate change.

A central demand of the agreement was the realignment of financial flows. Article 2.1c explicitly called for financial flows to be brought into line with climate targets. As a result, the financial sector made voluntary commitments. In Germany, for example, leading financial players committed to aligning their portfolios with the Paris goals and aimed to measure, publish and reduce portfolio-related emissions. Sustainability funds were part of this initiative. The products had already experienced a first spring shortly after the turn of the millennium, but remained a marginal phenomenon due to a lack of common standards, a limited selection and also in view of turbulent stock markets in the noughties.

Second wave for ESG funds after 2015

This changed after Paris. Until then, most investors saw investments in sustainability funds primarily as an expression of their ethical and normative ideas and preferences. At that time, the motto was: sustainability funds invest in companies that have an above-average carbon footprint, respect employee rights and have the interests of shareholders in mind. The question of performance was - justifiably - more of a secondary issue.

For most investors, however, ESG funds were not tangible, as there was no link between sustainability characteristics and traditional financial indicators. Winning an ESG beauty prize did not necessarily mean delivering a good performance. This was unsatisfactory for the fund industry because generating returns is part of its DNA. What followed is legend. The investment industry's narrative quickly changed. Initially, it was said that there was no evidence that ESG funds had performance disadvantages compared to conventional funds (this is controversial; results vary depending on the market phase, investment strategy and timing).

In the next stage of sales expansion, the message was that ESG funds were a tool for risk management (this is questionable because market risk is the main focus of funds). This ultimately led to the conclusion that ESG funds had alpha potential. The fact that sustainability funds outperformed in the low interest rate environment due to their high proportion of tech stocks was deliberately overlooked. The fact that ESG funds were attributed structural performance characteristics (in technical jargon: factors) was controversial among academics, but did not prevent fund providers from at least suggesting this. As a result, investors bought ESG funds like there was no tomorrow. At times, half of all new money in European funds flowed into sustainable investment products.

Then came inflation in 2022. ESG funds fell by the wayside (keyword: clean energy ETFs), and the sales dreams evaporated. Since then, sustainability funds have performed poorly; funds that track the broad market without exclusions have performed well. Funds that invest in manufacturers of weapons, commodities and energy producers have also achieved very respectable returns since 2022, taking risk into account. Meanwhile, accusations of greenwashing are causing problems for fund providers in the USA and Europe. Because this brought the regulator onto the scene, hundreds of funds were downgraded from sustainable to conventional by the providers in 2023 and 2024. So-called dark green funds were often reclassified as “light green”. None of this helped to reassure investors. Funds with “impact” claims in particular were redeemed on a large scale in 2024 - partly due to their poor performance.

Lessons from the ESG hype phase

What remains after the flash in the pan of 2016 to 2021? The realization that the fund industry has once again overstepped the mark with unbridled marketing. Investors can also be accused of believing all too readily in the myth of ESG's performance characteristics. The impact of ESG funds was completely overestimated, and the overly brash linking of return prospects and sustainability characteristics caused considerable damage. Other players have not covered themselves in glory either. So far, there has been little discussion of the fact that providers of sustainability ratings have also acted as initiators of ESG indices, thereby laying the foundations for ESG ETFs. Supposedly neutral rating agencies have thus become stool pigeons for product providers.

The most important lesson for investors is that they should not aspire to save the world and get rich at the same time with ESG funds and ETFs. Sustainability funds are tools for expressing ethical preferences. If this temporarily correlates with good performance, that's fine, but it doesn't have to stay that way in the long term.

By Ali Masarwah, 10 February 2025, © envestor.de

Ali Masarwah is a fund analyst and managing director of envestor.de, one of the few fund platforms that pays cashbacks on fund sales fees. Masarwah has been analyzing markets, funds and ETFs for over 20 years, most recently as an analyst at the research house Morningstar. His expertise is also valued by numerous financial media in German-speaking countries.

This article reflects the opinion of the author and not that of the editorial team of boerse-frankfurt.de. Its content is the sole responsibility of the author.