Morgan Stanley
  • Institute for Sustainable Investing
  • Aug 17, 2023

Sustainable Funds Beating Peers in 2023

A rebound in growth stocks helped sustainable funds beat traditional funds in the first half of 2023, as assets under management rose and ESG investors increased their use of restriction screening.

In the first half of 2023, sustainable funds saw a median return of 6.9%, beating traditional funds’ 3.8% and reversing their underperformance in 2022, according to a new “Sustainable Reality” report from the Morgan Stanley Institute for Sustainable Investing. Investor demand also remained strong as sustainable funds’ assets under management (AUM) reached record levels.

“Our mid-year update shows the resilience of ESG funds with a return to outperformance after a challenging 2022,” says Morgan Stanley's Chief Sustainability Officer and CEO of the Institute for Sustainable Investing Jessica Alsford. “Investors are increasingly turning to sustainable funds with sustainable AUM now at ~8% of total AUM globally.”

Understanding 2023 Fund Performance

Last year, a rapid rise in interest rates contributed to declines in both equities and bonds. Value stocks (those trading cheaply) and high-quality, short-duration fixed income benefited, which contributed to the relative underperformance of sustainable funds in 2022, since sustainable funds tend to skew away from these categories. This year, a rebound in growth stocks (which prioritize long-term potential) has especially helped sustainable funds’ relative outperformance.

By asset class, sustainable equity funds posted the strongest gains, showing a 10.9% median return and outperforming traditional equity funds’ 8%. Fixed-income outperformance was more muted, with sustainable funds at a 3.8% median return vs. traditional funds’ 2.2% (see Figure 1).

Sustainable Funds Beat Traditional Funds in First Half of 2023
Median Return by Asset Type

Source: Morgan Stanley Institute for Sustainable Investing analysis of Morningstar data. *"Other" includes multi-asset, property, commodities, and alternative fund types.

In the first half of the year, sustainable funds attracted cumulative inflows of $57 billion, with almost all flows in Europe. That brought assets under management (AUM) to more than $3.1 trillion—or almost 8% of total global AUM—by the end of June, though still short of a record reached in 2021 (see Figure 2). Regionally, Europe continues to outpace other geographies in terms of sustainable AUM and fund counts. The majority (89%) of total sustainable funds are based in Europe, compared to 10% in North America and less than 2% in all other regions. By fund count, Europe is home to more than two-thirds of the world’s sustainable funds, followed by North America (12%) and Asia (7%).

Sustainable Funds’ AUM
In U.S. Dollar Billions

Source: Morgan Stanley Institute for Sustainable Investing analysis of Morningstar data.

Growth in Restriction Screening

Restriction screening, which investors use to try and limit exposure to certain issuers, products or activities based on their values or regulatory requirements, has risen sharply in recent years. More than 20% of total global AUM now uses at least one restriction screen, a surge from just 2% in 2019 (see figure 3). Controversial weapons, thermal coal and tobacco are the most-used screens.

One reason for this increase is the EU’s recent Sustainable Finance Disclosure Regulation (SFDR), which sets out mandatory ESG disclosure requirements for asset managers. As SFDR came into effect for European-domiciled funds in 2021, restriction screening use significantly increased. In Europe, almost 60% of AUM uses screens, compared to 8% in Asia and less than 2% in North America.

Rates of Restriction Screening Rose in Europe After SFDR
Any Exclusion, as % of AUM

Source: Morgan Stanley Institute for Sustainable Investing analysis of Morningstar data.

Looking Ahead

Should prevailing market conditions persist in the latter half of 2023, sustainable funds should continue to benefit, given their more growth-oriented, longer-term positioning. However, a return to a market environment that favors value or shorter-term assets has the potential to impact future performance, as seen in 2022. Even so, sustainable funds’ AUM is likely to continue increasing, as inflows have largely weathered volatile market conditions and as investor demand for sustainable funds grows.