EU Fund Withdrawals Not Necessarily Cause for Alarm
Assets in Luxembourg-domiciled ESG funds continue to rise, but institutional investors are broadening their horizons as tensions build between short- and long-term priorities.
The realities behind recent institutional investor withdrawals from Luxembourg-domiciled ESG funds hold greater complexity than first meets the eye, according to the lead author on new research.
The latest benchmark report from PwC Luxembourg, co-published with the Luxembourg Sustainable Finance Initiative (LSFI), follows a challenging year for sustainable investment in Europe, but suggests asset owners are becoming more sophisticated and selective in their approach.
Luxembourg is by far the leading domicile for UCITS ESG funds in the EU, offering a key indication of the broader market’s sustainable investment trends and future direction of travel. The country houses 45.7% of the total AUM of Sustainable Finance Disclosure Regulation (SFDR) Article 8 funds and 60.8% of AUM for Article 9 funds, ahead of Ireland, France and Sweden.
The third annual sustainable finance report found that in H1 2024 institutional investors had withdrawn €7.8 billion (US$8.2 billion) from UCITS ESG funds domiciled in the country. In October, Morningstar Sustainalytics found that investors had pulled €2.2 billion from funds classified as Article 9 under the EU’s SFDR in Q3, marking the fourth consecutive quarter of redemptions for the ‘dark green’ funds.
However, Frederic Vonner, Advisory Partner in Sustainability and Sustainable Finance at PwC Luxembourg, told ESG Investor the headline figures do not necessarily suggest waning appetite for green investments. “One potential reason is that we have institutional investors moving into unregulated vehicles, or investing new money into such vehicles, which is not captured by the report,” he said.
Withdrawals from SFDR-classified Luxembourg-domiciled ESG funds by institutional investors in H1 2024 were almost half of the €15.2 billion of outflows in H1 2023, and marginally down on the €8.9 billion in H2 2023. Institutional investors also pulled significantly more capital from non-ESG funds, at €11.5 billion, in the first half of this year.
PwC Luxembourg and LSFI’s 2023 report noted that investors were shifting their investments towards private markets, which Vonner has seen continue into this year, partly accounting from the institutional investor withdrawals from UCITS ESG funds. “Private market funds are an area which we have seen mostly institutional investors being exposed to,” he added.
Private market ESG funds domiciled in Luxembourg totalled €622.8 billion in 2023, an increase of more than 95% from five years ago, and up from €440.4 billion in 2022. Vonner highlighted private equity and infrastructure as being the two private market ESG funds asset classes seeing the majority of investment. Private equity AUM in 2023 totalled €267.5 billion, followed by infrastructure at €188.9 billion.
Shifting momentum
There have been undoubted headwinds for sustainable investment in recent years, with inflation, geopolitical tensions and 2024’s domestic elections lending uncertainty. But there are some signs investor appetite has weathered the storm.
Sustainalytics found that funds classified as EU SFDR Article 8 had registered the highest inflows since late 2021 during Q3 2024, netting €38 billion of new money, up from €26.5 billion in Q2. Despite Article 9 funds seeing outflows for more than a year, withdrawals in Q3 were down by €4.3 billion from a record €6.5 billion in Q2.
Sustainability-related policies have been amended or delayed in Europe, while politicisation of ESG is expected to continue under US President Donald Trump. But Vonner said he has “not seen major pushback against ESG, or people saying it’s becoming irrelevant”.
PwC Luxembourg and LSFI’s report found the AUM of ESG funds domiciled in the country had reached almost €3.3 trillion by the end of June 2024. This marked a 12.3% increase from the low of €2.9 trillion reported in H2 2022.
ESG UCITS made up 73.3% of the total €4.4 trillion UCITS AUM in Luxembourg in H1 2024, with ESG funds accounting for 5,288 out of the 9,597 active funds in the country.
Another potential indicator of the health of sustainable investing in Europe – the number of green funds available – may also require closer attention. Sustainalytics found that across Europe, 86 Article 8 and Article 9 funds had closed in Q3, bringing the total number of closures since January to 337.
However, Vonner said that, unlike non-ESG funds which tend to liquidate when they close, Luxembourg-domiciled ESG funds have typically merged. This is reflected in the increase of total ESG fund AUM despite the overall number of funds declining.
“To me, it’s a sign that ESG funds closures are not driven by a lack of interest in ESG policy, but likely more because of fund rationalisation and economies of scale,” he added.
Short-sighted approach
However, tensions between investors’ short- and long-term priorities has been a feature of 2024 which is likely to shape the market over the next 12 months.
Vonner said some asset managers were frustrated at the “limited investment universe” imposed by ESG considerations, adding that they view such considerations as making it “more complicated to generate financial performance”.
“If you look at the oil and gas crisis a few years ago, for asset managers to benefit from that financial performance, they had to go to outside the scope of ESG funds,” said Vonner. “That might be a partial explanation as to why we’ve seen a decrease of institutional investor inflows, because it’s easier to achieve financial performance outside of ESG funds than with ESG funds.”
These tensions are evident among asset owners as well as managers. EY’s 11th annual institutional investor survey released earlier this week found that 92% of respondents do not believe it is worth sacrificing short-term performance for the longer-term potential benefits of ESG investments.
Gleaning the views of 350 key decision-makers from investment firms worldwide, including asset managers, 66% also said that ESG considerations are likely to play less of a role in investment choices over the coming years.
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