What the future holds for sustainable and ESG funds

In the golden years of sustainable investing, in the run-up to 2022, it was common to hear fund managers argue that sustainability was also a driver of returns and outperformance. While this may well turn out to be true in the long term, it has not been the case for some time, and the outlook remains complicated for funds investing with a sustainable mindset.

While the potential for a new energy price shock may encourage more nations to pursue decarbonisation strategies over the medium term, the short-term impact is less helpful. Jason Hollands, managing director at Bestinvest, notes that many of the sectors that appear poised to perform well in the current environment are those that sustainable funds tend to avoid, including oil and gas and defence. Each of these received an initial boost back in 2022 when Russia attacked Ukraine; it seems likely that the war in the Middle East will continue to boost them for a while longer.

Tobacco stocks have also done well over the past month “as many investors have started to adopt a more defensive stance in their portfolios in the face of geopolitical uncertainties and worries about an AI bubble”, Hollands says.

Even the energy transition itself is not always a clean business, which complicates things further. “Miners have also been a hot sector, benefiting from soaring gold and silver prices, but also demand for metals that are key to both energy transition and AI infrastructure,” Hollands says. “Most environmental, social and governance (ESG) funds have low exposure to extractive industries because of their high environmental impact.”

Darius McDermott, managing director of Chelsea Financial Services, also points out that sustainable funds tend to have a quality growth bias, which has been out of favour as markets rotate towards more value-focused, capital-intensive sectors, including banks as well as energy and defence. And of course the political picture remains tricky too, particularly in the US.

The result is that investors are no longer as keen as they used to be on these funds. The Investment Association estimates that UK retail investors pulled £2.9bn-worth of these assets in 2023, £4.8bn in 2024 and £5.9bn in 2025.

The picture looks slightly less bleak if you look at Morningstar’s broader data, covering all funds domiciled in Europe: 2025 was the first year of outflows – $62bn (£47bn) in total – and flows were in the green for January and February this year, but of course this was before the US and Israel attacked Iran.

Against this mixed backdrop, the Financial Conduct Authority (FCA) rolled out its sustainability disclosure requirements (SDR) regime between 2024 and 2025, with most of the new rules now being fully in effect. The changes mean that UK funds that want to use words such as ‘sustainable’ in their name and marketing have to follow certain criteria and define what kind of sustainability goal they pursue.

According to FE data, the Investment Association universe currently lists roughly 5,500 funds in total. Of these, only 106 have taken an UK SDR label so far; this compares with 1,365 funds across Europe, of which 1,254 are ‘Article 8’ or ‘light green’ funds, and 111 are ‘Article 9’ or ‘dark green’ (following stricter criteria) funds.

There are various reasons for this, including the fact that the European requirements have existed for much longer, and that the UK rules don’t apply to funds domiciled overseas, which in practice substantially limits their efficacy. However, it is also true that the UK rules are fairly strict and have arguably had some success in limiting greenwashing, with some firms opting to remove references to sustainability in their funds’ names rather than applying for an FCA label.

Global fund ideas

The table below shows some of the best performing sustainable funds in the Investment Association global sector over the past year, among those available on DIY investment platforms. Most have underperformed both the index and their peers over the past few years – although of course markets have been exceptionally strong, meaning that in many cases absolute performance has still been more than acceptable.

The one-month performance column gives a sense of which funds have been particularly impacted by the war in the Middle East. As it stands, they have all lost more than the index and the average conventional global equity fund.

Royal London Global Sustainable Equity (GB00BL6V0581) features a mix of usual suspects and surprising names in its top 10 holdings. Largest positions include Taiwan Semiconductor Manufacturing Company (TW:2330), or TSMC, Nvidia (US:NVDA), Microsoft (US:MSFT) and Alphabet (US:GOOGL) – but it is also significantly overweight to the UK, which accounted for nearly 16 per cent of the portfolio as at the end of January (against 4.9 per cent for the MSCI All-Country World index). Standard Chartered (STAN) and Rentokil (RTO) were the third and 10th-largest holdings, respectively.

Hollands likes Schroder Global Sustainable Value Equity (GB00BF783V38). The fund “focuses on companies within the cheapest 20 per cent of the MSCI World Index, combining a disciplined value approach with robust sustainability criteria”, he says. “We regard the team as a best-in-class allocator of capital within sustainable value equities.” The fund has a fifth of its portfolio in the UK, with Vodafone (VOD) and GSK (GSK) as the largest and third-largest holdings, respectively.

The past year has been fairly good to Ninety One Global Environment (GB00BKT89K74) and Baillie Gifford Positive Change (GB00BYVGKV59), well-known funds that had been going through a difficult period prior to this. The first has a specific environmental focus, while the second focuses on a broader range of themes, including poverty and healthcare. They are relatively concentrated, with 30 and 37 holdings, respectively, and TSMC represents a good chunk of both portfolios (just shy of 7 per cent for the Ninety One fund and more than 9 per cent for Baillie Gifford).

It’s worth noting that the list features the open-ended Impax Environmental Markets (IE00BZ1LW551), rather than its investment trust counterpart, Impax Environmental Markets (IEM). This is because the trust is still trying to fend off US activist Saba Capital, via a 100 per cent cash exit offer for investors – what is left of the trust after that might well fall under the activist’s control, resulting in a very different investment strategy.

The best-performing sustainable funds often have some overlap with global indices, and a significant exposure to the ‘Magnificent Seven’. Impact funds, by contrast, focus more explicitly on companies that have a positive impact on society.

FP WHEB Sustainability Impact (GB00B8HPRW47) has strong environmental credentials, but performance remains muted, with the portfolio still slightly in the red on a five-year basis. Hollands also suggests M&G Positive Impact (GB00BG886B02), a concentrated global equity strategy investing in 25-35 companies that are addressing major social and environmental challenges.