Why are ESG-oriented ETFs going away?

Firms managing investment funds are rebranding or in some cases closing exchange-traded funds (ETFs) that were previously associated with environmental, social and governance (ESG) goals amid political and regulatory pushback.

ESG investing has grown in prominence over the last decade and ESG-themed funds have become increasingly accessible, with leading financial institutions offering ETFs and other investment products that aim to promote corporate policies and practices aligned with ESG goals. 

However, the last few years have seen a growing pushback against ESG investing. Regulators have cracked down on greenwashing by companies exaggerating the sustainability of their operations as well as funds that failed to abide by their stated investment criteria. Several states have cut ties with asset managers over their ESG practices, particularly opposition to fossil fuel production, while the ESG focus on stakeholder value over shareholder returns has turned away some investors.

"About four years ago, it was something that was being marketed from a fund company lineup all the way down to [registered advisers] and financial institutions talking about the ESG offerings they had, and now I don't hear that being marketed hardly at all except for maybe from financial planning firms who target clients who want to be specifically invested in ESG," Jim Crider, CEO of Intentional Living FP, told FOX Business.

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Crider said that when ESG investing peaked in the pandemic era, such funds were able to rise along with the broader market, which helped mask disparities in performance that would emerge under other market conditions. After it surged during the 2020 market rebound, the 2022 pullback amid the inflation surge prompted a reevaluation of investors' priorities.

"At first it was the greenwashing, virtue signaling and the rising tide that lifted all boats that led to the adoption," Crider said. "And then the drop-off was market pullback, layoffs, tightening on the wallet met with, 'Hey, what is actually in this thing? I need to prioritize my investments, this thing doesn't necessarily have the social impact I thought it did, so it's not accomplishing what I hoped it would from that standpoint, and it's not having the returns per se, so I need to go back to something more normal.'"

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A report by ETF.com citing data from Bloomberg Intelligence found that as of May, at least 20 ESG ETFs were shuttered in the first half of this year after last year saw 23 ESG ETF closures. 

Among the funds that closed in early 2024 were a trio of ESG ETFs offered by WisdomTree Asset Management that faced scrutiny from the Securities and Exchange Commission (SEC). 

The regulator rebuked WisdomTree Asset Management over misstatements and compliance failures related to three ETFs that were marketed as being ESG despite investing in companies engaged in fossil fuel extraction, including coal and natural gas, as well as the retail sales of tobacco products. Among the issues identified were that the firm's screening process lacked policies and procedures to screen out such companies as the ETF represented it would.

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The firm closed the funds in January and the SEC's order came down in October. WisdomTree agreed to a cease-and-desist order and censure along with a $4 million civil penalty, though it didn't admit or deny the agency's findings.

The ESG backlash has also prompted some fund managers to rename ETFs to avoid running afoul of the SEC's name change rule, which could land them in hot water if terms like "ESG" or "sustainable" are determined to be misleading.

"The 'ESG' and 'sustainable' tags are subject to heightened and often arbitrary oversight from various regulatory bodies," Jordan Rodriguez of Wernick Spear Wealth Managers told FOX Business. "The risk and hassle of the above was worth it for the marketing potential, but with the changing sentiment among investors and the general public, there is less, if any, benefit to carrying those identifiers." 

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Investors are increasingly pulling funding from ESG and sustainable investment funds. Morningstar reported that in the second quarter of 2024, investors withdrew $4.7 billion in funds from sustainable U.S. investment funds, marking the seventh-straight quarter in which sustainable funds experienced net outflows. That followed a much larger outflow in the first quarter which amounted to nearly $9 billion.