Sustainable Funds Face Big Challenges. Only Some Will Be Winners.


Investors couldn’t get in fast enough. In April 2021,
launched a new exchange-traded fund aimed at identifying the winners of the transition to a low-carbon world. It raised a record $1.25 billion in one day, making it the largest-ever ETF debut. The success underscored the exploding demand for products tailored to environmental, social, and governance, or ESG, investing—those with a mission of addressing complex problems such as climate change and economic inequality.

Last year, however, the story began to sour. Many ESG, or “sustainable,” funds—the terms are used interchangeably—suffered from poor performance, missing out on rallies in oil and coal. The strategy came under attack from conservative politicians decrying “woke capitalism.” Others charge that the strategy has little to show when it comes to improving life on the planet. The industry was also rocked by some high-profile scandals.

All this has prompted some to question whether ESG investing—even as it continues to attract huge amounts of assets—needs an overhaul. For investors, the upshot may be that some ESG funds can perform quite well, but it may have less to do with their screening methods and more with old-fashioned stock-picking.

Ken Pucker, a senior lecturer at the Fletcher School at Tufts University, argues that ESG investing delivers little to no social or environmental benefits and doesn’t generate alpha, or market-beating returns. Yet investors have continued to pour money into sustainable strategies at a pace that far exceeds that of traditional funds, he notes.

In the third quarter of 2022, the latest period with data available, global sustainable funds attracted $22 billion of net new money, while the broader market had $198 billion of net outflows, according to Morningstar. In the U.S., sustainable funds garnered a small net inflow of $459 million, compared with outflows of $86 billion for the total universe of U.S. funds and ETFs.

“On a relative basis, flows to ESG funds remain healthy, as compared to traditional funds. So one could say that from the asset managers’ perspective, the ESG model isn’t broken. Actually, it has proven very resilient,” says Pucker, who has written extensively on ESG investing. “From the perspective of the planet, ESG is almost irrelevant. And from the perspective of the individual or institutional investor who thinks they are getting either alpha or impact, I would argue it is broken.”

Fund / Ticker Morningstar Category 15-Year Annualized Return 15-Year Annualized Excess Return vs. Category Average (percentage points)
First Trust Water / FIW Natural Resources 10.1% 8.8%
Parnassus Value Equity / PARWX Large Value 12.9 6.2
Invesco Water Resources / PHO Natural Resources 6.9 5.6
Valic International Socially Responsible / VCSOX Foreign Large Blend 5.0 3.7
Calvert Core Bond / CLDAX Intermediate Core Bond 5.6 3.2
Parnassus Core Equity / PRBLX Large Blend 10.4 2.9
Praxis Growth Index / MMDEX Large Growth 10.5 2.3
Boston Trust Walden Small Cap / BOSOX Small Blend 9.2 2.2
Invesco Global Water / PIO Natural Resources 3.5 2.2
Calvert Equity / CSIEX Large Growth 10.3 2.1

Note: Data as of Nov. 30

Source: Morningstar Direct

Morningstar said the continued growth of U.S. sustainable funds even during a period of poor performance could signal that investor demand for sustainable funds is more “sticky” than broader U.S. demand.

It also suggests that investors still want to invest in a way that aligns with their beliefs—or that they see integrating ESG metrics into financial analysis simply as good risk management.

The challenge for such investors is how to find mutual funds and ETFs that are making a difference to the planet and delivering solid returns over the long term. There are a number of asset managers and funds that check both boxes, but doing so has become more complicated. And to understand why, one needs to rewind to early 2022.

As Barron’spreviously reported, Russia’s invasion of Ukraine triggered the first real test for ESG. By eschewing traditional energy stocks and defense shares, which had a banner year, and embracing low-carbon-footprint technology stocks, which didn’t, many ESG funds fell short. The average sustainable U.S. equity fund fell 19.5% in 2022, while the S&P 500 Total Return Index was down 18.1%, according to Morningstar Direct.

Over the course of 2022, the pushback against ESG escalated sharply, particularly in Republican-led states. In Florida, for example, Gov. Ron DeSantis and the State Board of Administration adopted a resolution barring the state from considering ESG factors in its investment management practices.

While most major asset-management firms offer some ESG options, BlackRock (ticker: BLK) has emerged as the leader in the space—and as its public face. It’s no surprise that it has been directly targeted by efforts to oppose investments that weigh the impact of climate change or diversity.

In December, North Carolina’s state treasurer called for the ouster of BlackRock CEO Larry Fink over the asset manager’s stance on ESG investing. Dale R. Folwell, in a letter to the board of BlackRock, wrote that Fink’s “focus on ESG is not a focus on returns.”

That followed activist hedge fund Bluebell Capital Partners’ urging of BlackRock’s board to remove its CEO. Bluebell, a $250 million hedge fund, said BlackRock had failed to fulfill its commitments under ESG principles, partly because it continues to invest in coal-producing companies such as

ESG investing also came under fire from a BlackRock alumnus. Terrence Keeley, author of the new book Sustainable: Moving Beyond ESG to Impact Investing, says mutual funds and ETFs driven by ESG metrics are neither generating impressive returns nor making meaningful progress against their main, nonfinancial goal of climate change. ESG, he adds, is “fatally flawed” and investors should refocus their portfolios on impact investing, or what he refers to as “purpose-driven investing.”

Keeley says he compared ESG ratings for similar companies and found they “were all over the map.”

“The principal criticism, which I think needs to be critically examined, is this notion that ESG scores may one day generate alpha,” he says. “It was taken for granted that ESG was going to be this elixir, this extraordinary divining rod that would allow investors to understand where asset prices were going. But when I looked into how ESG ratings are created and how materiality is factored into decision-making, I lost faith in this conviction.”

In the foreword to Keeley’s book, Fink writes that sustainable investing “remains one of the most frequent topics” that clients ask about. While the number of clients looking to incorporate sustainability into their portfolios has continued to grow, so has the criticism of sustainable investing. “It has sparked a lively debate,” Fink says. “It’s a debate I welcome.”

In a statement to Barron’s, BlackRock said: “Our investment conviction is that ESG-integrated portfolios can provide better risk-adjusted returns to investors over the long term. But the money we manage is not our own—it belongs to our clients around the world who choose to invest in many different ways.”

While last year’s oil boom and accompanying tech stock slide caused many ESG funds to underperform, there is no definitive long-term evidence that ESG strategies perform better or worse than their peers.

According to Morningstar Direct, of 69 mutual and exchange-traded funds with ESG investment strategies that have 15-year track records, 44 outperformed their fund peers—across both sustainable and traditional strategies in the same category—and 25 underperformed.

There are ESG funds with exceptional performance, such as
Parnassus Value Equity
(PARWX), which has beaten 99% of its category peers in the past 15 years with an annualized return of 12.7%, and the
First Trust Water
ETF (FIW), which has beaten 99% of its category peers in the past 15 years with an annualized return of 10%. Similarly,
Parnassus Core Equity
(PRBLX) has beaten 98% of its peers over the same period with an annualized return of 10.2%.

The good news is that there are a number of choices available for those who want to invest with a social or environmental conscience and not necessarily accept mediocre or subpar returns as the price.

“Are we asking anyone to take a haircut in return as it relates to [sustainable] investing? The data is clear. We are not. I would not ask anybody to do that,” says Mindy Lubber, CEO of sustainability nonprofit Ceres. “People have to do their homework like they would when buying any other fund.”

Green Century Funds pursues a dual approach to investing: exclusions, or negative screens, combined with shareholder advocacy. The funds don’t invest in fossil fuels, tobacco, nuclear and conventional weapons, genetically modified organisms, and other industries “whose core business threatens the environment and public health.” During the 2021-22 shareholder season, the firm worked with 80 companies and persuaded 20 of them to adopt new policies that reduce plastic pollution, protect tropical forests, and increase the use of renewable energy.

Investors can choose from three funds, one active and two passive:
Green Century Balanced
(GCBLX), an actively managed fund that invests in the stocks and bonds of “solution-oriented companies”; the passive
Green Century MSCI International Index
(GCINX), which invests in companies with outstanding ESG ratings in developed markets outside of the U.S.; and
Green Century Equity
(GCEQX), a passively managed fund that invests in sustainable U.S.-based companies.

Two of the funds have generated excess returns over 15 years: Green Century Balanced has delivered 15-year annualized returns of 6% as of Nov. 30, the most recent data available—an excess return of 1.2% compared with the category average, according to Morningstar Direct. Green Century Equity has returned 8.6% over the same period, eking out 0.3 percentage point of excess return.

Leslie Samuelrich, president of Green Century, which has about $1 billion under management, says the firm offers a place for investors “who want to align their values deeply on environmental issues,” including climate change, biodiversity, forest protection, plastic pollution, and factory farming.

The Impax funds, managed by Impax Asset Management, offer investors several choices when it comes to fossil-fuel-free mutual funds, including the Morningstar five-star rated
Impax Large Cap
(PAXLX). The fund was down 16.6% in 2022, hurt by a large overweight to technology stocks, but was in the top quartile for its category in 2021, 2020, and 2019.

Impax is one of the firms that Alyssa Stankiewicz, associate director of sustainability research at Morningstar, calls a leader in terms of its commitment to sustainable investing. Julie Gorte, senior vice president for sustainable investing at Impax, says the firm is investing in “the transition to a sustainable economy.”

In 2020, Morningstar started ranking money managers’ commitment to ESG in leader, advanced, basic, and low categories. Stankiewicz says three U.S. firms that are strong examples of leaders are Boston Trust Walden, Calvert, and Parnassus, noting that their ESG roots date to the 1990s or earlier, and their brands remain synonymous with sustainable investing.

The Morningstar five-star-rated Boston Trust Walden Small Cap fund (BOSOX) was one of the best performers in 2022, down 7%. (The S&P 500 index was down 19%.) For the year through Dec. 13, the fund was in the top 6% of its peers. Two other strong performers:
Baywood SociallyResponsible
(BVSIX), up 1.9%, and
Mesirow Small Company
(MSVIX), down 2.8%, to place it in the top 1% of its peers.

Investors need to check that the funds they select are offered by asset managers that are committed to sustainability, not just paying lip service, and that the companies in their portfolios have earned their spot for the solutions they are providing, not simply because of an ESG score.

“Hold your advisor accountable,” says Chat Reynders, chairman and CEO of Reynders McVeigh Capital Management, a socially responsible investing and wealth management firm. “If they claim to be using ESG as part of the process, ask them to explain what you own and why you own it.”

Write to Lauren Foster at

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