Europe’s ESG ETF industry proves resilient

Against challenging market conditions, socially responsible ETFs in Europe continued to see robust investor demand in 2022, according to data from financial research house Morningstar.

Demand for ESG-tailored products represented two-thirds of total ETF net inflows in Europe during 2022.

In Morningstar’s Q4 2022 European ETF Asset Flows Report, the financial research house observes that Europe’s ETF industry attracted total net new assets of €78.4 billion last year.

While this figure was significantly lower than the €160bn gathered in 2021, it compares favourably to strong outflows recorded from active mutual funds during 2022, highlighting how the benefits of the ETF structure, including daily liquidity, potential tax advantages, and lower fees in general, helped the ETF industry to better weather the market storm in 2022.

Despite the positive flow picture, significant declines in equity and bond market valuations drove Europe’s total ETF assets under management down from €1.41 trillion to €1.32 trillion by the end of the year.

ESG resilient

Morningstar notes that one of the most significant flow trends during 2022 was investors’ continued support for ESG-tailored ETFs which gathered €51bn net new assets, despite these strategies underperforming more mainstream exposures over the year.

Socially responsible ETFs represented roughly two-thirds (65%) of the industry’s total annual net inflows, up from 53% in 2021. Total assets invested in ESG ETFs also grew from €235bn to €248bn over the course of the year and already represent 18.8% of the industry’s total market capitalization, also up from 16.7% in 2021. Morningstar notes ESG’s proportion of the total AUM figure is even higher at 20.5% if ETCs are excluded from the calculation.

ESG outlook

Bloomberg Intelligence (BI) has already recently released research into the current and expected future state of Europe’s ESG ETF market, noting that flows and total asset levels could continue to see strength, primarily led by favourable policies in the region.

According to BI’s Global Asset Managers Outlook, ETFs designated as Article 9, Europe’s ESG class with the highest sustainability credentials, which gathered more than a third (36%) of ESG-related ETF net inflows in 2022, will likely continue to drive demand.

BI notes, however, that the ESG category risks being diluted as an increasing number of funds that classify themselves as Article 8 but don’t explicitly label themselves as ESG are entering the fold. Additionally, with stricter transparency under reporting rules expected to invite greater scrutiny of the ESG segment this year, an increasing number of Article 9 funds are expected to be downgraded to Article 8 in 2023.

Examining trends within the ESG segment, BI’s research highlights that climate-focused strategies have become an oversaturated corner of the market. While several such products have already been shuttered, BI believes this trend will continue in 2023 as oversupply tests demand and slower flows drive less-competitive strategies to close.

On clean energy and low-carbon strategies, BI notes that demand is also likely to continue waning. While the Inflation Reduction Act supports clean energy flows over the long term, BI does not think this will be enough to sustain recent rapid expansion which saw about 100 new climate-related ETFs introduced through Q3 2022, fewer than the 180 over the whole of 2021 but still double the number of product launches in any other year.