Decrease in Sustainable Fund Assets by €1 Trillion in Q1 Due to Market Instability and ESMA Regulation modifications
In the first quarter of 2025, European sustainable investment funds experienced a significant setback, with a decline of €1 trillion in assets under management (AUM). This downturn was particularly pronounced for Article 9 funds, which saw their AUM shrink to 66.5% of the previous quarter's total.
The decline can be attributed to several key factors. For the first time, quarterly outflows of USD 1.2 billion were recorded for European sustainable investment funds, marking a notable shift after a long period of inflows. Although this outflow represented less than 0.05% of the total assets (which stand at USD 2.7 trillion), it signalled a significant reversal in trend.
Underperformance relative to conventional funds and market benchmarks has contributed to investor hesitation. From 2018 to 2023, sustainable global-equity funds generally outperformed their peers. However, since late 2023 and into 2024, their performance lagged. This underperformance is partly linked to sustainable funds avoiding certain sectors, such as weapons manufacturers, which delivered strong returns.
Investor preferences and fund rebranding efforts have not significantly driven outflows. Most rebranded funds retained their sustainability focus, and investors demonstrated loyalty despite short-term underperformance. However, the general market conditions and performance challenges present headwinds.
Broader market and economic factors, including a general market shift and some sectoral downturns, may also affect flows into sustainability-themed funds indirectly by impacting confidence in renewable or sustainable sectors. For instance, the EU solar market is projected to experience its first annual decline in a decade in 2025 due to waning energy crisis support and weaker corporate power purchasing agreement markets.
Funds with exposure to alternative energy and water utilities continued to lose assets, contributing to the overall decline. The decline was primarily driven by falling asset prices and major outflows from Article 9 funds. Sustainable equity funds in Europe were the best-sellers in their category, drawing €14.91 billion, but this was not enough to offset the losses.
Article 8 bond funds were the quarter's top performer, attracting €41.27 billion in net flows. However, this was not enough to prevent the overall decline in sustainable fund assets. The ESMA's new labelling regime for green funds, which entered into force in May, has sparked a steep drop in funds being labelled sustainable.
Money market funds followed with €36.66 billion in net flows. Despite this, US-focused sustainable equity funds shed €4.02bn, despite attracting €14.8bn overall. Over the same period, 757 funds dropped ESG-related terms, representing €399.81bn in assets.
These trends reflect growing investor concerns about the repercussions of global trade wars. It is important to note that no direct mention of securitized product issuance or credit quality changes adversely affecting sustainable funds was found in the data for Q1 2025; these factors seem less relevant here.
The decline in Article 9 funds was particularly steep, with dark green Article 9 funds dropping from €344.89 billion to €251.1 billion. This decline suggests that investors may be reassessing their commitment to the most stringent sustainability standards, particularly in a challenging market environment.
The Q1 2025 decline in European sustainable investment funds represents a significant setback for the industry. However, it is important to remember that investor loyalty remains strong, and fund rebranding has not spurred outflows, suggesting the decline is primarily a performance and market-driven correction rather than a loss of conviction in sustainability principles.
- The decline in Article 9 funds, which focused on the highest environmental standards, can be linked to the drop in investment in environmental-science sectors, such as renewable energy and water utilities, due to broader market and economic factors affecting renewable or sustainable sectors.
- Despite the recent underperformance of sustainable funds compared to conventional ones, there is evidence that finance and business leaders continue to prioritize sustainable investments, as Article 8 bond funds attracted significant net flows in the first quarter of 2025, demonstrating an ongoing interest in environmental-science and climate-change initiatives.
