Cash investors trigger US$29b spike in ESG-lite funds

AFTER bleeding client money all year, Europe’s least stringent ESG fund category saw a sudden spike in inflows last month.

The about-face came as UK pension managers reallocated funds in response to the economic shock triggered by the proposed reforms under then prime minister, Liz Truss. Much of that cash made its way into money-market funds that carry the EU’s weakest ESG designation, known as Article 8. 

The upshot is that an environmental, social and governance fund class that investment clients spent the first nine months fleeing saw 28 billion euros (S$39.8 billion) of inflows in October, according to data compiled by Bloomberg.

The development feeds into a wider debate around the ESGness of cash and cash-like investments, as analysts point to significant variations in the contents of highly liquid Article 8 funds.

About half of Europe’s money-market funds now carry an Article 8 classification, according to Minyue Wang, a director at Fitch Ratings, who expects that share to increase as investors increasingly gravitate toward shorter-term assets. 

ESG integration “appears to be the main approach for our sampled top Article 8 MMFs,” Wang said. And Article 8 requirements “are to an extent open to manager interpretation.”

In order to qualify as Article 8, a fund needs to “promote” sustainability, under EU rules. But the fund category has drawn criticism from lawyers for becoming a catch-all product that provides clients with little insight into how their money is being used. 

It’s the latest indication that Europe’s landmark set of ESG rules – the Sustainable Finance Disclosure Regulation – may not provide end-investors with the safeguards they need to be sure their money is going toward a cleaner, fairer planet. EU regulators have started to acknowledge some of the shortcomings, and are trying to close the gaps that have emerged since SFDR was enforced in March 2021. 

Sterling money-market funds saw record inflows in October, as UK pension funds roiled by a cascade of collateral calls raced to increase their cash cushions. That’s amid a broader rethink of strategies as less liquid investment products lose their appeal in an environment of rising interest rates and volatility.

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Last month’s biggest inflows among Article 8 MMFs went to BlackRock’s ICS Sterling Liquidity fund, the Bloomberg data shows. It holds short-term instruments issued mostly by banks, and tries to avoid entities engaging in activities “inconsistent with ESG criteria,” according to fund documents.

Article 8 funds, which according to EU rules are supposed to “promote” sustainability, suffered US$29 billion of outflows in the third quarter, bringing the total cash exodus over the first nine months to more than US$120 billion, according to Morningstar. A more stringent ESG category under EU rules, known as Article 9, saw inflows of about US$30 billion in the same period.

Money-market funds are primarily sought out by investors as an ultra-safe way to get liquidity, and that’s a characteristic more readily found in Article 8 funds than in Article 9. So the current shift among investors toward short-term, more liquid allocations looks set to favour Article 8, without the equivalent “big push” hitting Article 9, Fitch’s Wang said. BLOOMBERG