Sustainable investing has grown up: Are your portfolios keeping pace?

Client demand for sustainable options is not just persistent; it’s evolving. After a brief dip, European sustainable funds attracted $11.3bn in inflows in Q2 2025, reversing earlier outflows, according to Morningstar.

Q3 saw record outflows of $51bn, largely due to a pension fund transfer from BlackRock funds into BlackRock custom ESG mandates not captured in Morningstar’s data. Excluding that, net outflows were a modest $3.1bn, primarily driven by passive strategy outflows, while active funds attracted $6bn in inflows.

These fluctuations don’t undermine the long-term trend. The sustainable investment market continues to mature, and advisers need portfolios that are fit for purpose.

The diversification dilemma is over

For years, building sustainable portfolios meant compromise. The toolkit was limited, largely equities. In other asset classes, at best, we could screen out the ‘baddies’ and pick the ‘goodies’, inevitably leading to concentrated portfolios. Or worse, accepting holdings that didn’t reflect the same sustainability standards. Genuine diversification felt like a luxury sustainable investors couldn’t quite afford.

Thankfully, that era is behind us. The sustainable investment universe has undergone a seismic expansion. A quiet revolution has brought a host of diversifying asset classes into the fold, each managed with the same rigour and ethical focus we once reserved for equities. This is a game-changer, opening up the ability to construct resilient, all-weather sustainable portfolios that don’t sacrifice client values.

Fixed income’s green makeover

The bond market has moved far beyond simply avoiding controversial issuers. Today, we have a thriving market for labelled bonds – Green, Social, and Impact Bonds raise capital for defined projects, like renewable energy and social housing. This provides a direct line of sight from the investment to the real-world outcome. Sustainability-Linked Bonds are issued by companies with strong ESG credentials, linking financing to their overall operational integrity.

This isn’t a niche corner of the market anymore. By June 2025, cumulative issuance of Green, Social, Sustainability, Sustainability-Linked, and Transition (GSS+) bonds had reached $6.3trn, with annual issuance hitting $1.1trn in 2024 alone, according to World Bank stats.

Bricks, mortar and morals

Property and infrastructure were once hard to access with a sustainable lens. Now there are funds targeting two key areas: sustainable real estate – improving energy efficiency, extending building life, and managing land responsibly – and “future-fit” infrastructure, financing energy grids, battery storage, and environmentally responsible data centers. These assets strengthen diversification while contributing directly to a sustainable economy.

Smarter, greener strategies

Even absolute return investing and hedge funds are evolving. Where strategies were once agnostic about real-world impact, we now see funds designed to capture market opportunities created by the transition to a more sustainable world – identifying firms decarbonising most effectively or providing innovative solutions.

Would a rose by another name really smell as sweet?

Managers are now becoming more thoughtful with derivatives. Instead of using broad index futures containing unwanted exposures, they create bespoke baskets to avoid them and ensure their synthetic positions align with sustainable principles. Counterparty policies are tightening too, ensuring trading partners meet responsible investment criteria. The result: portfolios that maintain ESG integrity throughout.

New tools to drive change and capture returns

This expansion is about more than just better risk management; it’s about making a difference in the world. When sustainable investing was confined to equities, our main levers were engagement and voting. These remain vital, but we can now influence outcomes across the entire capital structure.

By investing in green bonds, we directly fund the projects that are building a cleaner world. This multi-asset approach allows investors to harvest potential ‘greenium’ performance advantages from multiple sources, not just equity markets. Engagement in these alternative asset classes also helps shape the very structure of the instruments coming to market and the resulting impact they can have.

How to navigate the new landscape

As a member of Parmenion’s Ethical Oversight Committee (EOC), this evolution is precisely what we’ve been working towards. For too long, we had to build portfolios with one hand tied behind our back. Now, we have access to a full suite of tools that were once only reserved for conventional investors.

Our role on the EOC is to stay at the forefront of this change – scanning the market, conducting deep due diligence on these emerging portfolio diversifiers. We’ve already begun allocating to labelled bonds within our ethical portfolios, applying our rigorous screening criteria to this growing asset class.

Our ambition is to thoughtfully and progressively incorporate these diversifying assets into our solutions. We want to build portfolios for your clients that are not only aligned with their values but are also more resilient and capable of capturing the diverse returns offered by the sustainable economy. The market is maturing rapidly, and we are proactively researching these opportunities to ensure Parmenion’s ethical solutions remain robust, credible and fit for the future.