Sales of mutual funds focused on climate initiatives have experienced a sharp decline of 75% over the past two years, grappling with a combination of challenges ranging from high-interest rates to lackluster performance and a political campaign in the United States against socially conscious investments.

According to provisional figures from data provider Morningstar, climate-focused funds attracted a mere $37.8 billion in new investor money in 2023, a stark contrast to the record-breaking $151 billion seen in 2021. This marked the lowest net inflows since 2019, a year that witnessed a surge in interest in environmentally friendly investments.

This decline in sales is occurring at a critical juncture for climate finance, especially as the world experienced its hottest year on record, characterized by extreme weather events, droughts, wildfires, and flooding. A report by the Climate Policy Initiative emphasized the urgent need to increase climate finance at least fivefold from the $1.3 trillion recorded in 2021-22 to mitigate the worst effects of climate change.

Marcus Björkstén, a portfolio manager at Fondita Fund Management, attributed the struggles of some climate-focused funds to challenges stemming from inflation and high interest rates triggered by the coronavirus pandemic and Russia’s war on Ukraine. Concerns about energy security following the Ukraine conflict have boosted the share prices of fossil fuel companies, dampening enthusiasm for certain clean energy investments.

Hortense Bioy, global director of sustainability research for Morningstar, noted that despite the slowdown, green mutual funds are still performing better than the broader market. She stated, “There is still money flowing in, but it is less than previous years because of the macro environment.”

The broader category of Environmental, Social, and Governance (ESG) mutual funds reported its first-ever quarter of outflows at the end of 2023, with global investors withdrawing $2.5 billion. High interest rates have prompted investors to shift money from longer-term funds to higher-yielding money market funds and cash products.

Political figures such as French President Emmanuel Macron have urged the private sector to play a larger role in climate initiatives, especially in light of the strain on public finances caused by the pandemic. Irish environment minister Eamon Ryan expressed concern over the drop in new investments in climate-focused funds but emphasized that they are just one component of a larger picture.

Despite the challenges, private equity and debt, along with multilateral development banks, are emerging as crucial sources of climate finance. François Gemenne, a professor at HEC Paris Business School, underscored the ongoing importance of investment funds in meeting global climate goals, even as the environment for these funds and the companies they invest in remains challenging.

Several countries have backtracked on green plans, contributing to investor nervousness about policy changes. Renewable energy companies have faced disruptions in the supply chain, rising costs, and higher interest rates, leading to the abandonment of some projects that are no longer economically viable.

Shares of renewable energy companies, such as Ørsted and Nibe, have experienced significant declines over the past two years. The S&P/TSX Renewable Energy & Clean Technology index fell by almost 37% between the end of 2021 and 2023.

Despite the gloomier outlook, Marcus Björkstén emphasized the continued need for green business and investment due to the worsening effects of climate change. Hortense Bioy highlighted the enduring positive factors for climate-focused funds in the long term, particularly after countries at the COP28 climate summit in December committed to transitioning away from fossil fuels by 2050 and significantly increasing renewable energy capacity and energy efficiency by 2030.

Morningstar data revealed that total assets under management in climate-focused funds increased by 14% in 2023, reaching almost $522 billion.
By Delino Gayweh
Serrari Financial Analyst
January 28, 2023