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Sustainable Funds See Another Year of Broken Records

Mutual Funds

Sustainable funds in the U.S. broke nearly every previous record in 2021, according to Morningstar’s annual Sustainable Funds U.S. Landscape report. 

According to the firm’s data, sustainable funds attracted nearly $70 billion in net flows in 2021, which was a 35% increase over the previous record set in 2020. As a result, assets in sustainable funds landed at a record $357 billion at the end of 2021, more than four times the total three years ago. Even so, the report acknowledges that these new record inflows remain small compared with the rest of the market, as traditional U.S. fund flows also set an all-time record at more than $1 trillion for the year.

Still, as U.S. flows into sustainable funds have gained traction, asset managers have responded by expanding their sustainable fund lineups. Morningstar notes that the number of sustainable open-end and exchange-traded funds available to U.S. investors increased to 534 in 2021, up 36% from 2020. In addition, 121 sustainable funds were launched in 2021, surpassing the previous record of 71 set in 2020. Additionally, 26 existing funds adopted sustainable mandates in 2021, matching the record set in 2020. 

In the fourth quarter of 2021, 45 funds were launched in the U.S. with sustainable mandates. “This is the highest number of sustainable funds launched in one quarter, handily beating the previous record of 38 funds set the previous quarter,” writes Morningstar analyst Alyssa Stankiewicz, the author of the report. 

In discussing sustainable investing approaches, the report notes that in reference to the Morningstar Sustainable-Investing Framework, the most common strategy is to limit ESG risks, and that increasingly, traditional funds consider these risks—even those that do not claim to be sustainable investments. Other approaches to sustainable investing include employing exclusions and seeking ESG opportunities. 

Active Versus Passive 

While active funds continue to represent the majority of sustainable assets, the share has been on the decline, as investors have shown a preference for passive funds, the report further observes. At the end of 2021, 375 of the 534 sustainable funds available to U.S. investors were actively managed offerings, representing 70% of the landscape. Three years ago, however, active funds claimed 81% of sustainable assets, but by the end of 2021, that percentage shrunk to 60%. Consequently, low fees and increased investor adoption of model portfolios have boosted passive fund flows, the report notes.

Actively managed sustainable funds attracted about 11% of overall active flows for the year, while passive ESG funds claimed nearly 5% of overall passive flows. In addition, for the third consecutive year, investors pulled money out of actively managed U.S. equity funds but added money to their sustainable counterparts, the report notes.  

In addition, for the first time, sustainable fixed-income fund flows broke $10 billion in annual flows. The number of sustainable fixed-income funds has increased substantially since 2015, to 74 from 20. “More fixed-income choices help investors fill their bond allocations, making ESG-focused multi-asset portfolios more viable and ultimately helping drive more flows,” the report states. 

Overall, sustainable fund flows constituted roughly 6% of overall net flows into stock, bond and allocation mutual funds in the U.S. in 2021.

Investment Performance 

Meanwhile, compared with 2020, sustainable funds encountered greater performance challenges in 2021, but they continued to deliver strong returns versus category peers and their respective Morningstar category indexes, the report notes. On the whole, sustainable funds outperformed their peers in 2021, but by a narrower margin than in previous years. The report adds that slightly more than half of sustainable funds finished in the top half of their Morningstar category, led by equity funds. 

“While sustainable funds employ a wide variety of approaches and can be found in virtually every Morningstar category, sustainable equity funds commonly skew toward growth stocks and avoid traditional energy stocks,” the report explains. In 2020, these tilts were in favor, but in 2021, value and energy-sector equities both led markets during most of the first quarter, from Nov. 9, 2020, through March 8, 2021. As a result, some equity funds within the firm’s sustainable funds landscape may have suffered during these rallies, though most recovered to deliver solid calendar-year results. 

ESG Options for Retirement Savers

Morningstar’s report also addresses what the impact on various regulatory developments might have on sustainable investing. It notes, for example, that if the Department of Labor’s proposed rule making it easier for employers to offer sustainable funds in their workplace retirement plans is finalized as expected in 2022, it may “nudge employers” to integrate ESG considerations in making investment selections. This would give retirement plan participants more opportunities to select funds with ESG mandates. “In turn, this could spur more investment managers to consider ESG risks as part of the effort to maximize long-term risk-adjusted returns,” Stankiewicz notes.