Environmental, social and governance (ESG) funds are bleeding and managers don’t know what to do about it. According to Morningstar’s third quarter 2023 report on Sustainable Finance Disclosure Regulation (SFDR) Article 8 and 9 funds, the responsible investing universe is haemorrhaging money due to frantic reclassification as asset managers realize that climate change is real and so are the EU’s disclosure rules.
Depending on where you stand, this is either really good news for sustainable finance or a mayday moment.
Crisis mode
According to the report, investors withdrew €20.5 billion in the third quarter, marginally better than the €21.5 billion of withdrawals in the second quarter. The third quarter also saw the lowest level of subscriptions for Article 9 funds since the introduction of SFDR in March 2021, with only €1.4 billion going into ‘dark green’ vehicles.
Meanwhile, Article 8 funds are also suffering more than Article 6 funds – those that don’t have a sustainable investment focus but are required to disclose the integration of sustainability risks in the fund – which continued to gather net new money in the third quarter amounting to €17.8 billion.
The responsible investing universe is haemorrhaging money due to frantic reclassification as asset managers realize that climate change is real and so are the EU’s disclosure rules
“The dwindling inflows can be attributed to a combination of economic and regulatory factors, including the great reclassification between the last quarter of 2022 and the first quarter of 2023. [When] around 350 Article 9 funds were repositioned to the Article 8 category,” the report states.
After this panic episode, when managers thought they would rather be safe than sorry, investors are now moaning about the new balance of the ESG fund universe: a handful of really-clean-really-green Article 9 funds versus a mass of somewhat-sustainable Article 8 funds, some of which do the bare minimum to upgrade from 6 to 8, and some of which are just shy of the Article 9 title.
Indeed, Morningstar found that nearly 280 funds altered their SFDR status last quarter, including 250 upgrades, most of which were from 6 to 8. It’s great to have more specific categories of green funds that respect the difference between ESG compliance and impact investing, but without any money those labels won’t go very far.
The price of integrity
Of course, now that managers know what kind of information they need to have about their portfolio allocations in order to warrant the Article 8 or 9 title, this may improve the process of sustainability reporting.
And now that investors know what it takes to be called an impact investor, they will be looking for managers who can actually deliver an authentic Article 9 fund.
Perhaps the wave of reclassification is a necessary cull of fund strategies that don’t deliver the sustainable performance needed, before a new age of dark green begins.