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Sustainability Matters

U.S. Sustainable Fund Flows Slid in First-Quarter 2022

But demand showed resilience amid a broader U.S. market slowdown.

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U.S. sustainable fund flows posted their fourth consecutive decline as inflows fell to $10.6 billion in the first quarter of 2022. That's less than half of the all-time flows record, nearly $22 billion, set one year ago in the first quarter of 2021. Although flows into sustainable equity funds have declined recently, sustainable fixed-income funds have experienced steady growth, climbing by 9% to reach $3.2 billion.

In the first quarter of 2022, assets in sustainable funds dipped for the first time in two years, to $343 billion. To put it in perspective, assets in sustainable funds fell by 4%, but assets in the overall U.S. market fell by 6% over the quarter.

Asset managers continued to launch new sustainable funds, one fifth of which focus on climate action. One such fund, iShares Paris-Aligned Climate MSCI USA ETF (PABU), only launched in February 2022 but ended the quarter with $636 million in assets.

Flows Fell for the Fourth Consecutive Quarter

Last quarter, flows into U.S. sustainable funds dipped by 26% compared with the fourth quarter of 2021. But demand for sustainable funds showed higher resilience when compared with the broader U.S. funds market, where flows dipped by 65% to $85.7 billion. Confronted with rising market risks, high inflation, and lofty valuations, this was the weakest quarter for U.S. fund flows since the first quarter of 2020, which was heavily influenced by the onset of the pandemic and a bear market.

During the quarter, sustainable funds attracted 12% of total U.S. fund flows, compared with an average 6% of quarterly U.S. flows over 2021.

A chart depicting U.S. sustainable funds flows versus total U.S. market flows.

Weaker flows into sustainable funds affected active and passive strategies alike during the first quarter. Demand for sustainable active funds slipped for the third consecutive quarter, attracting $4.8 billion for the period.

In recent years, investor preference has shifted toward low-cost passive funds: Passive strategies have attracted about two thirds of quarterly sustainable fund flows on average over the past three years. However, the split last quarter was close to 50/50, with passive funds netting $5.7 billion for the period.

A bar chart of active and passive U.S. sustainable fund flows over the past 12 quarters.

A New Floating-Rate Bond Fund Surged to the Top

Though flows were split evenly between active and passive, eight of the 10 funds attracting the most flows in the first quarter of 2022 were passive funds. Invesco Floating Rate ESG (AFRAX), which topped the chart in the first quarter, was the top fixed-income fund in terms of annual flows last year. Having only repurposed to a sustainable mandate in the second half of 2020, this fund has seen strong early adoption by the market. In the face of rising interest rates, investors may seek to use floating-rate bonds as a hedge, helping this fund garner assets.

Remarkably, iShares Paris-Aligned Climate MSCI USA ETF only launched on Feb. 8, 2022, but it secured fourth place among the sustainable flows leaders, attracting $608 million during the quarter. Climate-focused investing has grown immensely over the past few years, raking in nearly $13 billion in net flows in 2021.

Five of the leaders were also in the top 10 for the fourth quarter of 2021. In addition to Invesco Floating Rate ESG, iShares ESG Aware MSCI USA ETF (ESGU), Vanguard ESG U.S. Stock ETF (ESGV), Vanguard FTSE Social Index (VFTNX), and Fidelity U.S. Sustainability Index (FITLX) made the cut again. Notably, ESGU has defended its position on the leaderboard since the third quarter of 2019.

Top 10 U.S. Sustainable Fund Flows in Q1 2022
A table of the 10 sustainable funds with the most inflows in the first quarter of 2022.

Some of 2021's Flows Leaders Fell Behind Last Quarter

Some of the funds with the strongest inflows during 2021 topped the chart for outflows in the first quarter of 2022, indicating that investors may be redeeming from funds that have seen widespread demand. For example, iShares MSCI USA ESG Select ETF (SUSA), Parnassus Core Equity (PRBLX), and BlackRock U.S. Carbon Transition Readiness ETF (LCTU) were all on the leaderboard for 2021, with annual flows of USD 1.7 billion, USD 2.4 billion, and USD 1.4 billion, respectively.

Bottom 10 U.S. Sustainable Fund Flows in Q1 2022
A table of the 10 sustainable funds with the most outflows in the first quarter of 2022.

Investors Shifted Focus to Sustainable Bank-Loan and Emerging-Markets Funds

Over the past two years since the coronavirus-driven selloff, markets have grown tremendously, but as that enthusiasm wanes in the face of rising volatility and inflation, investors have begun to diversify their portfolios. Although sustainable funds in the large-blend and foreign large-blend Morningstar Categories continued to attract the majority of flows (and offer more sustainable options than other categories), there was increasing demand for bank loans, core and core-plus bond funds, and emerging-markets equities in the last quarter.

Though investors have only two sustainable options in the bank-loan category--Invesco Floating Rate ESG and Calvert Floating-Rate Advantage (CFORX)--that category secured fourth place in net flows for the quarter. Those two funds attracted USD 1.2 billion over the period, a 262% increase over the previous quarter. As more funds launch and build out track records in smaller categories, sustainability-focused investors will have greater choice during volatile markets.

A bar chart of the five categories with the most sustainable fund inflows in the first quarter.

Sustainable Bond Funds Attracted Record Flows

While flows into sustainable equity funds have steadily decreased in recent quarters, flows into sustainable fixed-income funds have grown. Last quarter, sustainable bond funds attracted a record $3.2 billion, which is more than 3 times the total seen three years ago. The number of sustainable fixed-income funds has increased substantially in the past three years, to 116 from 46. More fixed-income choices help investors fill their bond allocations, making environmental, social, and governance-focused multi-asset portfolios more viable and ultimately helping drive more flows.

A bar chart of the U.S. sustainable fund flows for the allocation, fixed-income, and equity asset classes over the past 12 quarters.

Assets in U.S. Sustainable Funds Dipped Below $350 Billion

Despite inflows, total assets in sustainable funds declined amid a broader U.S. market slowdown. They totaled $343 billion at the end of the first quarter, down 4% from the all-time record of $357 billion at the end of 2021. To put it in perspective, assets in the overall U.S. market fell by 6% over the quarter to $26.5 trillion. In the U.S. sustainable funds landscape, active funds retain the majority (59%) of assets, but their market share is steadily shrinking. Three years ago, active funds held 77% of all U.S. sustainable assets.

A bar chart of active and passive U.S .sustainable fund assets over the past 12 quarters.

One Fifth of New Sustainable Funds Focus on Climate

In response to increasing investor demand for sustainable offerings, asset managers have expanded their sustainable fund lineups. In the first quarter of 2022, 24 funds, including 15 ETFs, were launched in the U.S. with sustainable mandates. Of those, 17 were equity funds.

A bar chart of active and passive U.S. sustainable fund launches over the past 12 quarters.

Five of the new funds focus on climate action, such as Engine No. 1 Transform Climate ETF (NETZ), which targets companies that are either transitioning toward more-sustainable business practices or that are developing technologies to help others transition, and Goldman Sachs Bloomberg Clean Energy Equity ETF (GCLN), which seeks to invest in the clean energy transition including infrastructure improvements, renewable energy sources, and energy digitalization.

Two of the new offerings focus on driving impact through municipal bonds: BlackRock Impact Municipal Bond (MPICX) and Lord Abbett Sustainable Municipal Bond (LISMX). For example, the former seeks to benefit undercapitalized or high social opportunity areas through projects related to mass transit, low-carbon public power issuers, and access to healthcare.

Largest New Sustainable Funds
A table of the 10 largest new sustainable funds.

Firms Continued to Repurpose Funds for Sustainable Outcomes

Most of the new options available to investors were launched with sustainable mandates, but firms also occasionally change the investment strategies of existing funds to target sustainable outcomes. In the first quarter of 2022, just two funds were repurposed to adopt sustainable mandates. The largest of these was Nationwide BNY Mellon Core Plus Bond ESG (NWCIX), with $674 million in assets. The fund seeks to invest in securities that score well on the firm's proprietary ESG framework and allocates a portion of the portfolio to impact bonds, which direct the use of proceeds toward projects that achieve environmental or social progress.

U.S. Repurposed Funds in Q1 2022
A table of the two funds that were repurposed with sustainable mandates in the first quarter of 2022.

The new offerings and repurposed funds brought the total number of sustainable open-end and exchange-traded funds in the U.S. to 555 at the end of the quarter.

A bar chart of new and repurposed U.S. sustainable funds over the past 12 quarters.

For global sustainable fund flows for the first quarter, read our full paper.

Alyssa Stankiewicz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.