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Broad ESG funds lose out to 'greener' Art.9 vehicles in Europe

Investors in Europe are turning away from funds that focus on broad environmental, social and governance principles, and towards investments that demonstrate specific ESG investment objectives, with accompanying evidence.

In the nine months to the end of September, there was a net inflow of €32.8 billion for investment and exchange-traded funds classified as Article 9 products under the EU SRI regulation. Outflows from Article 8 products were as much as €173 billion, according to research by Refinitiv Lipper.

Article 8 funds, sometimes called "light green", must demonstrate that they generally promote environmental or social characteristics. Article 9 funds, on the other hand, focus on a sustainable outcome as a specific objective.

The current debate around 'greenwashing' and the lack of clear standards for categorising funds by the respective SFDR article could be reasons why the European fund industry witnessed outflows from Article 8 products. Reason being that these products are a kind of 'intermediate products' because while they support ESG criteria, they do not have a formalised ESG-driven investment approach, according to the Refinitiv Lipper report.

'Running away from greenwashing - that would be the main theme there,' The Financial Times quoted Detlef Glow, head of Lipper Emea research at Refinitiv, as saying. The continued demand for impact-oriented sustainable investments is all the more remarkable given the total outflows of €333 billion that Refinitiv Lipper recorded from the European fund sector in general in the first nine months of the year.

Analysts reveal in The Financial Times that there is huge potential for much better products that do the job better. With increasing focus on greenwashing and concerns about the level of disclosure, investors currently prefer a more definable investment objective or strategy. Fund managers do not want to take the risk, as evidenced by the increasing number of fund 'downgrades'. Morningstar research showed that 41 funds downgraded to Article 8 from Article 9 in the third quarter of this year. More are expected to follow in coming months.

The most challenging aspect of the SFDR is the new Principal Adverse Impacts (or PAI) regime. Principle Adverse Impact indicators are a set of mandatory indicators underpinned by hard data designed to show investors how certain investments pose sustainability risks. Under these new rules, fund managers, financial advisers and other financial institutions will have to collect ESG data and disclose all sustainability risks related to their investments and financial products. This also affects the real estate sector to a large extent.