On the bond front, sustainable bond funds experienced a significant increase in net inflows, totalling $19.6bn, soaring by 244 per cent from the previous quarter, despite investors lowering their expectations for rate cuts.
In Europe, sustainable funds registered almost $11bn of inflows, more than double the subscriptions of the previous quarter.
Meanwhile, in the US, sustainable funds saw its worst-ever quarter with $8.8bn in outflows.
Morningstar said the small first quarter net inflows showed that investor appetite for ESG and sustainable funds in Europe remained weak by historical standards.
Reasons for investor caution
The lower appetite could be attributed partly to the challenging macro environment, including high interest rates, inflation, and fears of recession in some parts of the world.
Also, some investors were taking a more cautious approach to ESG investing in the wake of the underperformance of ESG and sustainable strategies in 2022, partly owing to their typical underweight in traditional energy companies and overweight in technology and other growth sectors.
Hortense Bioy, global director of sustainability research at Morningstar, says: “ESG funds tend to be overweight in technology and underweight in energy. So they missed out on the great performance of energy stocks and were hit by the bad performance of technology stocks.”
While the technology sector rebounded in 2023, other popular sectors in sustainable strategies continued to underperform.
Renewable energy companies, for example, have been particularly affected by soaring financing costs, materials inflation, and supply chain disruptions, among other issues.
The Morningstar report added: “The more cautious approach taken by investors toward ESG funds has become particularly evident in the past three months when looking at the flows picture in the equity segment, as this is the asset class where ESG integration is much more advanced and easier to implement.
“This is happening amid a complex interplay of economic and political factors.
"While regulatory and funding support across Europe will continue to boost demand for sustainable products and services in general, governments are facing competition in allocating scarce public budgets between the digital transition, military expenditures, and investment in social infrastructure.
“They must also balance high inflation and interest rates with higher costs in public debt management. The political and business will to invest in the green transition may fall short in light of these competing factors.”
Alex Matcham, head of wholesale distribution at M&G, says: “All regions have something to offer from a sustainable investment perspective, but speaking very generally, emerging markets have particularly interesting options from a social impact and transition point of view.
“European companies are leading in terms of general ESG focus and disclosure. Europe plays an important role in renewables and clean tech, but the US, Japan and China also offer plenty of opportunities.”
