Canadian Sustainable Funds See Outflows Last Quarter

Ruth Saldanha: The latest Morningstar Sustainable Funds Landscape report found that in the third quarter of 2023, sustainable funds in Canada actually saw net outflows. This is the first time that this has happened since the second quarter of 2020. The report, which tracked the flows both into mutual funds and ETFs, found that outflows were the norm across the fund universe, and bonds were actually the only asset class to gain net new money. So what does this mean for investors interested in sustainable investing? Danielle LeClair is the Director of Manager Research for Morningstar Canada, and she's here today to talk about what she found. Danielle, thank you so much for being here today.

Danielle LeClair: Thanks for having me, Ruth.

Saldanha: So let's start by talking about what did you find for the last quarter?

LeClair: Yeah, absolutely. I would highlight four main themes. So the first one is the one that you let off in your intro, that we did see outflows in sustainable funds in Canada. It was to the tune of about $22 million. Now, when we looked at our global report, we did see generally interest and demand for sustainable products decreased across the globe, but those outflows in Canada was a little bit different from what we saw in other markets. Diving into that in a little bit more detail, if you look at the active versus passive split, we saw that the majority of the outflows were in passive products. It was a second consecutive quarter that we saw outflows from passive funds, and really we haven't seen a lot of meaningful inflows into passive products since about Q1 2022, whereas on the flip side, active funds were in positive territory. We saw new money go into those, and we have seen that pretty consistently over the last three-year time period that we're looking at in this report.

So the third point that I would make is something that you mentioned as well, the inflows into bond funds. So that's the second consecutive quarter that we've seen that whereas equities have been in outflow territory, so something notable there as well. And then the last point that I would make is on the performance side. So over the last one year, we are still seeing some pretty strong results. You know, 47% of sustainable funds are in the top half of their respective peer groups whereas on the quarter basis, on the third quarter basis, about 70% are in the bottom half of their respective peer groups. So there's been a turnaround there in performance as well.

Saldanha: So let's stick with the flows for a second. What are some of the reasons for the outflows in this quarter?

LeClair: You know, I think that there's a lot of things that we can see globally that we could point to on this. You know, pressures around what regulation is out there, different language terminology for what ESG is, there's still some uncertainty. And I think as that's coming to light, we are seeing some of the people pull some money from their respective sustainable funds. I would also point to just general fears of recessions. You know, you mentioned we did see outflows based off of our data in conventional funds as well. So there's some alignment there that we're seeing in trends from a macro perspective.

Saldanha: So one thing that I found interesting in the report is that you found that one single fund actually accounted for most of the outflows. So what's going on there?

LeClair: Yeah, it was the BMO MSCI USA ESG Leaders ETF (ESGY), which lost about $192 million in the third quarter of 2023, which was really just adding to the losses it's seen earlier in the year. It's actually the fund that's lost the most money from a sustainable funds perspective in Canada, up in and around $250 million that is lost. So those are few reasons that I could kind of point to that. I think generally speaking, I would lean into the recession fears and just generally investors switching from bonds to equity funds. You know, the U.S. market is the largest. It's the most liquid market out there. And so it would make sense that that would be disproportionately hit when it comes to outflows. But then the other thing that I would point, you know, this is pretty well known at this point, but in the U.S. market, there's those magnificent 7 stocks. And this fund doesn't have as much exposure to those. So there could be some of that that's playing into it as well.

The last thing that I would point into as well is, this report did not include fund of funds in our analysis, and that was done to avoid double counting. But a lot of these funds are within, these asset allocation products. And so anytime there's some shifting in asset allocation from a professional investor's perspective, that would also get reflected in these types of transactions.

Saldanha: Right. The last thing I'd like to ask is that despite all of this, despite all the outflows, new funds actually launched. So how should investors read the space right?

LeClair: Exactly, 13 new funds were launched in Q2, and we have seen kind of regular fund launches. That again is something a little bit different here in Canada where we saw globally that fund products, from a sustainable perspective, the launches were actually less. I still see it as a pretty healthy environment. If you look at inflows over the last year, we're still at $1.6 billion. So I do think that there's still a healthy interest in sustainable funds. You know, I mentioned regulation earlier. Something that I would point to as well is just the general improvements that we're seeing and the collaboration on different industry bodies to speak the same language when it comes to ESG. And that's really helping both investors figure out which products they want and also asset managers figure out which products that they should be offering to the environment for investors. So I think that that alignment is going to see continued interest in ESG funds.

Saldanha: Great. Thank you so much for joining us today, Danielle.

LeClair: Anytime.

Saldanha: For Morningstar, I'm Ruth Saldanha.