For Asset Managers, Sustainable Investing Becomes a 2-Speed World

Sustainable investors are getting ready to see what a two-speed world looks like. On Monday, President Donald Trump withdrew the US from the Paris Agreement, the global accord to fight climate change by slashing the greenhouse gas emissions that cause global warming.

On one side will be Europe, which has pledged to achieve “climate neutrality” by 2050, or net zero emissions, and nations around the globe committed to sustainability. Europe also has an ambitious mandatory environmental, social, and governance and sustainability reporting agenda.

On the other side is the US. At his inauguration, Trump said he planned to declare a national energy emergency, promote fossil fuels, and scale back support for renewable energy, including support for electric vehicles and offshore wind farms. Fossil fuels account for the vast majority of emissions.

The administration is “certainly hostile” to environmental, social, and governance investing,” write Morningstar analysts Lia Mitchell and Aron Szapiro. (ESG investing is frequently, but not always, interchangeable with sustainable investing because it’s used by investors aware of climate and other risks not necessarily accounted for by traditional financial metrics. For a look at the different kinds of sustainable investing, read this).

In advance of Trump taking office, the world’s six largest banks withdrew from a major climate coalition, with BlackRock BLK, the world’s biggest asset manager, pulling out of an equivalent group. Sustainably minded investors regard net zero alliances as important because nations, under the Paris Agreement, have set targets to reduce emissions. The financial industry plays an important role in this by financing companies. However, conservative states and politicians argue that financials firms are colluding to advance a climate agenda.

Also this year, a US District Court in Texas found that American Airlines AAL violated the law by including funds from investment companies that consider ESG goals. Among other things, the judge wrote, “The belief that ESG considerations confer a license to ignore pecuniary benefits is mistaken. Erisa does not permit a fiduciary to pursue a nonpecuniary interest no matter how noble it might view the aim.”

For asset managers and investors, here’s what the rest of the year might look like.

Expect More Government Pressure on Sustainable Investing

—Republican politicians are expected to scrutinize investment firms that try to reduce climate risk by using ESG approaches. They’ll also take a close look at investor coalitions, write Paul Davies and Betty Huber, partners at law firm Latham & Watkins.

—Expect agencies to roll back regulations requiring companies to disclose the risks to their business of climate change. Trump has also taken steps to halt diversity, equity, and inclusion programs within the federal government and elsewhere. (Many believe that DEI programs can help strengthen organizations by winning top talent and responding to different customer bases.) In turn, people-heavy businesses, particularly in technology, healthcare, and financial services, “are likely to reevaluate and update their practices and policies,” write Davies and Huber.

It Will Be Tougher to Invest Sustainably Through your 401(k)

Trump is likely to erect new barriers to ESG investing in retirement plans governed by law, by reversing a Labor Department rule adopted by the Biden administration that said plans could consider ESG factors. So while many investors will be able to incorporate ESG analysis, the exception is retirement accounts like 401(k) plans. “Regulations governing ESG in these plans will likely become much more challenging for plan sponsors, and that will discourage them from making ESG options available to their employees,” write Morningstar’s Mitchell and Szapiro.

Judicial challenges will come, too, following the American Airlines decision and ongoing suits filed by Republican states regarding investment plans that offer ESG options. (You can find out more about how to make your 401(k) plan greener here.)

Unless Sustainable-Fund Performance Improves, More Outflows Could Be in Store

Assets in US Sustainable Funds

In 2024, US sustainable open-end funds and exchange-traded funds suffered their second year of outflows in more than a decade, compared with significant inflows for conventional funds. Performance was a factor, with only 42% of sustainable funds landing in the top half of their respective Morningstar Categories. That’s causing fund closures to accelerate: In the US, there were 595 ESG funds at the end of September, compared with 647 at the beginning of the year. Since 2021, green investments, including wind, solar, battery, and electrical vehicles, have struggled to generate good returns for investors investing in public markets, mainly owing to high interest rates, writes Hortense Bioy, head of sustainable-investing research at Morningstar Sustainalytics. That struggle may continue if the Federal Reserve slows the pace of rate cuts and if Trump cuts tax credits for green projects.

Europe Will Widen Its Lead on Sustainable Investing

For asset managers, ESG was a promising opportunity. In theory, ESG-related investing would allow them to push products with higher profit margins, and to create economies of scale as they pursued global ambitions in which investor culture was focused on the benefits of ESG. Now that’s changing. Hence, a two-speed world.

—Europe, already in the lead with ESG, will widen the gap with the US. “The overall stock of sustainable AUM [assets under management] resides primarily in Europe, and US sustainable assets are only 11% of global sustainable AUM,” observes Joyce Chang, global research chair at J.P. Morgan. For asset managers, the implications are manifold.

—That creates some opportunities for European managers, who operate in a world where sustainability is mainstream. For example, it may be a selling point with asset owners, who oversee big pools of capital, such as pension funds or sovereign wealth funds. Some 67% of asset owners globally believe that ESG has become more material to their investment process in the past five years, according to Morningstar’s Voice of the Asset Owner survey, and every asset owner surveyed is allocating at least a portion of their assets to strategies that take ESG factors into account. “It’s very possible that asset owners will say they prefer to deal with European managers” particularly if they show greater expertise because of the perceived focus on ESG, says Morningstar’s Bioy. For example, “if impact investing is something asset owners want to focus on, asset managers will have to find ways of meeting those needs.” That could be more likely with a European manager than a US manager.

—For BlackRock, the world’s largest money manager, and the world’s largest manager of sustainable funds, this requires fancy footing. “I don’t see them stepping back from their ESG efforts in Europe or the Asia-Pacific region, even as they face stiff headwinds here in the US,” says Greggory Warren, a Morningstar strategist who follows BlackRock. “The firm is large enough and diversified enough to handle some of the negative attention ESG has received here in the states. That said, we’re still early innings on what ESG can and cannot achieve, how viable it is as an investment strategy, and whether the regulators will allow large passive investors like BlackRock and Vanguard, which can amass large positions in firms/industries, to continue to vote on shareholder proposals.” Like BlackRock, other US-headquartered managers will be “more pragmatic and do what clients want and not be too vocal,” Bioy says—more “greenhushing,” in other words. Bioy adds, “there will be less coordination, coalitions, alliances” on climate and similar matters.

—A similar approach might be required of other US asset managers that viewed ESG research as part of their fiduciary duty to anticipate risks for clients. Says Andy Poreda, responsible investing analyst at Sage Advisory Services: “We are now having to avoid anything with an ESG bent. That over the long term is problematic. We can see climate risk has an impact to performance of companies and human capital. This is part of the overall momentum, changing the view of asset manager from fiduciary role to product service.”

—So much for scale. “It’s a more fragmented market, where you align your marketing, product strategy, and communication to local differences. So potentially it could mean more costs. Some will do a cost-benefit analysis on certain markets, and think it’s not worth it,” says Bioy. “But it was never simple in the first place.”

US Support for ESG Proposals at Company Annual Meetings Could Fall Further

Already, support for ESG-related shareholder proposals has fallen sharply in the US. “They’ve become increasingly reluctant to support environmental and social resolutions at US companies,” says Lindsey Stewart, director of stewardship research and policy for Morningstar Sustainalytics. “We’re already at a low we haven’t seen in the last five years.” That’s particularly true with the Big Three: BlackRock, Vanguard, and State Street, the largest managers of index funds.

Why Sustainable Investing Will Persist in the US

Still, it would be a mistake to think sustainability considerations will vanish in the US. For example, California by law is requiring companies to make climate disclosures. New York’s new Climate Superfund law is requiring large fossil fuel companies to pay for projects that bolster New York’s resiliency to “dangerous climate impacts like flooding and extreme heat.” Some two thirds of the largest 2,000 global companies have net zero targets, notes Thomas Kuh, head of ESG strategy at Morningstar Indexes. “Through reporting for Europe, they’ll see the benefits and opportunities from actions related to climate and sustainability.”

Plenty of investors want to capture “the opportunity of the climate transition,” Maria Lettini, CEO of US SIF, the trade group for the sustainable-investment industry, recently said. “Broader global market trends, such as regulatory obligations, evolving client preferences, the transfer of intergenerational wealth, and the growing frequency and severity of financially material physical and transition risks associated with climate change, are certainly contributing to investors’ interest.”

And it’s uncertainty that inhibits long-term investment decision-making, Kuh adds. ExxonMobil XOM CEO Darren Woods, a critic of aggressive decarbonization efforts, stated that “[o]ne of the challenges with this polarized political environment … is the impact of policy switching back and forth as political cycles occur … and administrations change. That’s not good for the economy.” When asked about Trump’s plan to withdraw from the Paris Agreement, Woods noted, “I don’t think the challenge or the need to address global emissions is going to go away. Anything that happens in the short term would just make the longer term that much more challenging … I’ve been advising that we have some level of consistency.”