Growing pains of sustainability ease into better universe for investors and fund industry

Growth of sustainability continues while new regulation forces fund industry to get its act together, writes Morningstar. 

The fund industry needs to live up to its promises more than ever, as investors can make well-funded decisions to grant their assets to the fund house that does not only the best but also the most transparent job. Growth of sustainability continues while new regulation forces fund industry to get its act together.

Sustainability is key to society and to the investment industry. Retail investors are asking for it more and more and are actively seeking ways to give sustainability a prominent role in their investment portfolios. Morningstar’s fund flow data underline the ongoing growth of the green segment in the fund market.

The importance for the fund industry is once more underlined by the thematics of Morningstar’s upcoming Morningstar Sustainability Investment Summit on October 11 and 12 in Amsterdam. Morningstar was a frontrunner in making sustainability a key theme in fund research by introducing various tools that help investors to incorporate ESG when making their investment decisions, such as the Morningstar Sustainability Rating in 2016. Morningstar has been developing its tools further ever since, and that has led to the launch of new research products that serve the investment community with insights in specific areas of the fund industry. For example, Morningstar’s ESG Commitment Level addresses the way fund companies embrace sustainability; are they leading or lagging when it comes to incorporating sustainability in their investment process?

Rising demand from investors is the powerful natural driving force behind the growth of sustainability, but also new regulations make the industry focus on what they need to change. The Sustainable Finance Disclosures Regulation (SFDR) regulations package brought a lot of work to the industry’s plate; it is meant to outline what sustainability is, how it is incorporated into investment products, what their objectives are and – most important – how fund companies, asset managers and distributors should communicate with their end investors about it. An Article 8 fund is defined as promoting environmental or social characteristics (light green funds). Article 9 funds are those that have a sustainable investment objective (dark green funds). Article 6 funds are all other managed products.

After the new demands came into play, the industry hurried to align its products and communications with the new standards. But then the growing pains arose. Lots of funds were re-branded to ESG, apart from the many newly launched funds that were designed from scratch to apply, flowing into the market to meet the ESG demands of investors. But when the second phase of SFDR, starting January 2023, approached, the environment sort of changed. Doubts rose in the market about how green all those proudly presented products actually were.

Morningstar data show a material shift between the Article 6, 8 and 9 levels when development and checks made fund companies change the SFDR label of their funds in the course of 2022. Morningstar’s SFDR data show that towards the end of 2022, around 40% of the assets in Article 9 funds were re-categorised as Article 8. Quite a significant change, but it was the consequence of funds not living up to their ESG promises.

In the recent months of 2023, the fund industry took a breath and paused the launch of new sustainable funds, more or less, as Morningstar data show. Development towards ESG went on, and relatively many Article 6 funds made the step up to Article 8 status. Fund flows meanwhile show that investors keep moving into the remaining darkest green funds of Article 9, with quarterly inflows hovering between 5 and 9 billion euros. Article 8 funds topped that after the rebranding exercise of 2002 with an inflow of 25 billion euros in the first quarter of 2023. Overall, this means that de fund market is moving consistently more into ESG.

All these developments stress the fact that applying ESG properly is serious business. Therefore, working with in-depth data is essential. Otherwise, adopting ESG is no more than greenwashing, a criticism that is heard disturbingly often in recent times. That requires the fund industry ever more to counter that and make sure that it offers true ESG products that meet investors’ demands and that are based on thorough, well-designed strategies and data.

For all we know, the demand from end investors in the markets is here to stay. Especially new generations of investors who enter the markets appear to have a fundamentally different view on investing, where their personal values and sustainability are essential elements in the process of making their investment decisions. So, there is still a lot to come in this, and new insights will be given at the Morningstar Sustainability Investment Summit on October 11 and 12 in Amsterdam.

© 2023 funds europe

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