S-E Asia’s ESG funds record outflows in Q1 as investors shun regional equities

ENVIRONMENTAL, social and governance (ESG) funds in South-east Asia recorded net outflows in the first quarter of 2024, even as non-ESG funds pulled in more money.

Investment strategists told The Business Times that investors across the globe have generally been allocating their capital into money market and fixed income funds, whether they come with the sustainability label or not. 

South-east Asia’s ESG funds, which are mostly equity funds, have therefore been missing out. Nonetheless, some fund managers expect to see a more supportive environment for fund flows globally as the interest rate environment stabilises.

In Q1, ESG funds domiciled in Indonesia, Malaysia, Singapore and Thailand lost a net US$11.2 million, indicated Morningstar data.

This was a smaller outflow than the US$128.4 million recorded in the year-ago period, but represented a reversal of two consecutive quarters of net inflows in Q3 and Q4 of 2023.

Conversely, non-ESG funds in the region extended their two previous quarters of net inflows. A net US$13.3 billion of capital flowed into these funds in Q1 2024, versus a net outflow of US$1.3 billion in Q1 2023.

Both ESG and non-ESG funds reported negative returns in the quarter. ESG funds averaged a negative 2.6 per cent, versus a positive 4.4 per cent in Q1 2023.

Non-ESG funds did slightly better, with a negative 1.6 per cent. They returned a positive 2.7 per cent in Q1 2023.

Stephanie Choi, sustainable and impact investing strategist at UBS Global Wealth Management, said flows have been driven in part by portfolio rebalancing. 

As the higher interest rate environment persists, investors are locking in attractive yields, said Christopher Wong, client portfolio strategist for South-east Asia at Fidelity International. 

An emphasis on income-focused instruments disadvantages South-east Asia’s ESG funds, Choi said, as equity funds make up 81 per cent of ESG funds domiciled in South-east Asia. In comparison, equity funds account for 43 per cent of all funds in the region.

Wong also noted that flows towards non-ESG funds in the region were mainly towards money market and fixed income-related strategies.

Outflows from ESG funds, meanwhile, were mainly from global ESG-related equity strategies and an Asia ex-Japan ESG-related exchange traded fund. 

“This is likely due to the funds underperforming broader markets and concerns over the economy, interest rate policies and sector/country-specific developments,” Wong noted.

Among the sector-specific concerns, he flagged short-term headwinds such as a potential oversupply of electric vehicles (EVs) and the impact of higher interest rates on renewable energy companies.

ESG funds would typically include clean energy companies, which tend to have higher debt levels because of the capital-intensive nature of the business.

The market would be pricing in some concerns that higher interest rates could impact these companies’ ability to service their debts, Wong said.

ESG funds that do not hold or have little exposure to mega-cap stocks would also have underperformed in recent quarters, he added, as market breadth continues to be narrow and only a handful of stocks are driving returns – especially in the United States.

Outflows could also have been driven by profit-taking among the outperforming funds, while relatively strong inflows took place among the laggards at the country level, said Alvaro Vivanco, head of Latin America strategy and macro analysis at NatWest. 

He noted, in particular, that the biggest inflows into ESG funds were towards those domiciled in Thailand (net inflow of US$40.6 million), which also had the weakest returns of -6.79 per cent on average over Q1 2024.

On the other hand, some Malaysia and Singapore-focused funds experienced outflows following decent performance.

Volatility is expected for ESG funds in the region, but with some improvements in performance.

This is partly because sustainable investing remains relatively nascent within South-east Asia, and still only represents a small percentage of both assets under management and products available in the market, said UBS’ Choi.

“Fund flows volatility sparked by global market dynamics may show up more strongly in the region given there is a lower, and less entrenched, base. Moreover, the pace of product launches may have greater influence on fund flows when compared to the rest of the world,” she added. 

Many ESG funds typically focus on emerging technologies, Vivanco of NatWest added, which adds to performance volatility.

He believes central bank easing later in the year should help alleviate tight financial conditions and drive inflows, but also expects some consolidation in ESG funds as the sector continues to mature.

Fidelity’s Wong, however, warned that some sector-specific conditions – such as the slowing of EV sales – may persist.

Falling interest rates could also spur higher returns from, and in turn flows into, non-ESG funds. This is because fixed-income securities, which tend to do better in a lower-rate environment, make up a sizable portion of non-ESG funds, he added.

Choi said educating investors about sustainability investing in the region, including diversifying sustainable investing strategies beyond green thematic equities, would be key to sustained growth in the region.