Sustainable investing at the crossroads

As political winds shift and billions exit ESG funds, sustainable investing stands at a decisive turning point.

Sustainable investing is facing its toughest test yet. After years of rapid expansion, funds focused on environmental, social and governance (ESG) factors are seeing significant outflows, as political pushback, regulatory uncertainty and investor fatigue prompt a reassessment of these strategies.

In early 2025, global investors pulled $8.6bn from sustainable funds, the highest on record, according to Morningstar. US outflows continued for a tenth straight quarter, while Europe saw net redemptions for the first time, despite holding 84 per cent of global ESG assets. Appetite is waning even in its strongest market.

Despite outflows, global ESG assets rose 8 per cent year on year to $3.2tn, more than four times their 2018 level, highlighting its continued integration into mainstream investing. The PWM Global Asset Tracker survey reflects this mixed picture: just 18 per cent of private bank CIOs expect ESG inflows to grow in 2025, while a third foresee further declines. But over a longer horizon, sentiment remains cautiously optimistic (see chart).

Recent withdrawals of major US asset managers from climate alliances reflect political pressure, rather than a retreat from sustainable investing, according to Christopher Greenwald, head of sustainable investing at LGT Private Banking in Zurich. “There’s no fundamental change in how leading managers actually manage money,” he says.

Firms like BlackRock and JP Morgan Asset Management, along with large US banks, pulled out of climate initiatives amid legal and political scrutiny at the start of president Donald Trump’s second term. The move, he suggests, was driven by fears of congressional backlash, not a shift in emissions strategy.

While some pension funds have reallocated capital due to ESG concerns, which indicates a “commitment to stay the course”, Mr Greenwald sees no broad retreat among wealthy families or family offices, just a continued focus on avoiding greenwashing. “They want authentic managers who can back up commitments with real actions,” he notes. “If anything, this environment is encouraging more rigorous mandates.”

Beyond labels

For LGT, ESG investing has moved beyond labels. Its SFr21bn ($26bn) Princely Portfolio, co-invested with the Liechtenstein royal family, has been Paris-aligned since 2021, with ESG screening and decarbonisation across public and private markets. “This is about managing risk and identifying opportunity, not about turning portfolios upside down,” says Mr Greenwald.

The approach extends beyond sustainability mandates. All funds undergo internal ESG analysis via the bank’s proprietary Navigator tool, which covers more than 11,000 companies. Clients with strong convictions can opt for thematic strategies, but ESG analysis is now the default starting point.

“We don’t have a separate PM team managing sustainability funds. It’s a holistic process applied across all mandates,” he explains.

The term ESG has become distorted, argues Mr Greenwald, especially in the US. He suggests that fiduciary duty offers a more grounded framework. Recent research by MSCI supports this, treating ESG as a performance-enhancing investment factor, on par with momentum or quality.

Client preferences and long-term risk management are the real drivers of ESG integration, suggests Mr Greenwald, calling for stability over regulatory flux. “We don’t need more rules, we need time for the current ones to settle,” he says. “Constant changes only create confusion and reduce investor confidence.”

PWM’s GAT survey echoes this sentiment: almost three quarters of private bank CIOs cite client demand as the main force behind ESG adoption (see chart).

Call for pragmatism

Erika Karp, a New York-based consultant and former investment banker, puts it more bluntly: “There’s no such thing as ESG investing. ESG is not a style; it’s a discipline for investment research, an analytical process.”

She argues that ESG’s true value lies in enhancing transparency around investment decisions, something all investors want. “But transparency can be very disruptive,” she adds.

ESG, for Ms Karp, was rooted in fiduciary duty and materiality, long before it reached a political crossroads. “If you’re not considering material ESG risks, you’re not doing your job,” she says.

Her criticism extends beyond external backlash to what she sees as the industry’s own failings. “Too many ESG-labelled funds have launched without meaningful changes to investment processes,” she says. “The growth has been too fast and not thoughtful enough. The field has shot itself in the foot.” That lack of rigour, she argues, has undermined credibility and deepened investor scepticism.

Ms Karp prefers to shift the focus towards investment stewardship, aimed at “protecting and improving long-term value”. Sustainability is about how a business operates, not how it markets itself. Many successful companies have long managed ESG risks and opportunities — optimising operations, improving governance, and enhancing disclosure — well before these practices were grouped under the ESG label.

She stresses the importance of active ownership, warning against the delegation of responsibility from asset owners to proxy advisers. Encouragingly, some families and foundations are taking a more hands-on approach.

“Constructive engagement doesn’t have to be confrontational,” she adds. “If we can move more towards a constructive and open dialogue, it would benefit the entire field. Engagement can be more impactful than divestment.”

As for the idea that ESG hampers returns, she dismisses it: “Skilled managers can perform in any market.” There will be short-term volatility, but over the long run, ESG enhances understanding of risk, resilience and innovation.

In the end, she says, it is asset owners, families, foundations, long-term investors who demand the real change. “Asset managers and investment banks are often the short-term ones. That’s where the incentives need realignment.”

The end goal is clear for Ms Karp. “Sustainable investment should drive a more inclusive and regenerative global economy.”

Leaders over laggards

Recent outflows signify a reset rather than a retreat, according to Daniel Wild, Zurich-based chief sustainability officer at Bank J. Safra Sarasin. “Yes, we’ve seen a slowdown in flows into high-conviction sustainability themes or even outflows, likely because those areas aren’t performing as strongly. But the broader shift towards robust ESG integration across asset managers hasn’t reversed.”

His firm’s strategy avoids blanket exclusions, opting instead for a “leaders over laggards” approach in high-emitting sectors. Coal is excluded; oil may be phased out next, and natural gas remains under scrutiny, but the focus is increasingly on enablers of the transition.

“Power grids, transformer stations, storage, chips for electric vehicles, that’s where we see growth potential.” Dedicated funds have been launched to capture these downstream opportunities.

He draws a distinction between long-term climate strategy and short-term politics. Even under a deregulatory Trump administration, energy companies are unlikely to pursue high-risk projects — such as Arctic drilling — simply because policy shifts. “These projects have lead times that extend well beyond political cycles."

Meanwhile, a different kind of long-horizon investment is gaining traction: investor interest in defence stocks is rising, driven by Europe’s growing military budgets, the ongoing war in Ukraine and escalating tensions in the Middle East. Strong returns from major defence and aerospace companies, outperforming broader markets, have prompted many to reconsider their place in portfolios.

But ESG classification remains a sticking point. “We think it would be quite a stretch to include weapons or defence companies in a sustainable investment fund,” says Mr Wild.

A 2024 Morningstar report found that 87 per cent of ESG funds exclude controversial weapons manufacturers, and 59 per cent screen out small arms producers. Yet a quarter of European ESG funds now hold some defence and aerospace stocks, a marked shift from previous years.

The biggest challenge ahead is transparency, not labelling, believes Mr Wild. “The proliferation of ESG labels and ratings has confused clients. We need standardised reporting to allow informed decision-making.”

Realistic approach

He is critical of the regulatory patchwork, particularly in Europe, which he sees as burdensome rather than clarifying. Like many of its peers, the firm has removed ‘sustainable’ from some strategies, not due to a shift in approach, but because the funds no longer met evolving labelling criteria.

"What we need is clarity on exclusions, engagement practices, tracking error, and how strategies perform versus benchmarks, so investors can make informed choices.”

As COP30 in Brazil draws near, with countries under growing pressure to sharpen their climate goals, Mr Wild offers a pragmatic perspective on what that means for investors.

While President Trump may boost the appeal of fossil fuel investments in the short term, long-term threats — climate change, biodiversity loss and resource scarcity — remain top of mind for institutional investors, as highlighted by the World Economic Forum.

But the era of inflated promises is giving way to real-world implementation, says Mr Wild. “The financial world mirrors the real economy. It’s very difficult to expect a fossil fuel-free financial system while the real economy still heavily relies on fossil fuels,” he says. The role of finance, he adds, is to support firms through the transition.

“What might be going away right now is the philosophical commitment, the urgency, the ambitious long-term targets. But as a solid asset manager, I’d say: was that ever enough?”

The “overexcitement” surrounding sustainable investing five years ago has certainly faded, he concludes, but that is not necessarily a bad thing. “Now is the time for a more realistic, pragmatic approach. We need to move beyond vague targets and focus on genuinely embedding sustainability into the investment process.”