- ESG funds have shown robust performance in sectors such as IA Global, IA Japan, and IA North America, consistently outperforming their sector averages over 1, 3, and 5 years.
- In the IA UK All Companies sector, ESG funds have consistently underperformed compared to the sector averages over 1, 3, and 5 years.
- Mixed performance across analysed sectors highlights the need for careful selection of ESG funds to balance ethical goals with financial returns.
Environmental, Social, and Governance (ESG) investing has experienced a surge in popularity in recent years, reflecting a growing emphasis on sustainable and responsible practices. As investors increasingly prioritise these principles, the performance of ESG funds has come under closer scrutiny, particularly, can ESG funds deliver growth on par with traditional funds?
This article analyses the performance, sector ranking and overall rating of 168 ESG funds' performance compared to traditional funds, and identifies the sectors which ESG funds have consistently outperformed.
ESG Fund Performance Summary
We have analysed 189 ESG funds covering 7 investment sectors to assess their performance and effectiveness against their peers, over the past 1, 3 & 5 year periods.
From this diverse range of 189 ESG funds, only 15 were awarded a high performance rating of 4 or 5 stars, with 9 funds receiving a 4-star rating and 6 achieving the highest 5-star rating. Meanwhile, 58 funds had a moderate 3-star rating, reflecting average performance.
61.4% of these ESG funds demonstrated weak performance and underperformed relative to their sector peers. Specifically, 78 funds were given a 2-star rating, and 38 received a 1-star rating, reflecting poor returns across multiple time periods. This highlights the need for careful consideration when selecting ESG funds, as a significant portion has not managed to deliver strong and consistent performance.
How Competitive Are ESG Funds?
So far in 2024, ESG funds have experienced varying levels of performance across different sectors. In the table below, we analyse the performance of seven core Investment Association (IA) sectors over 1, 3, and 5-year periods. It highlights the differences between the average returns of ESG funds and the overall sector averages. Our analysis of these seven IA sectors indicates that ESG funds have experienced a mix of both outperformance and underperformance across different timeframes.
In the North America sector, ESG funds have consistently outperformed the overall sector average over the past 1, 3 & 5 years, by a difference of 4.06%, 6.97%, & 19.54% respectively. This outperformance is primarily due to many large-cap North American companies integrating ESG factors into their business models in response to regulatory pressures and increasing sustainability awareness.
The IA Japan sector also shows a positive trend where ESG funds have consistently outperformed the sector average across all three periods. Japan has seen a growing emphasis on corporate governance reforms, with companies increasingly adopting global ESG standards. These reforms have included improving board independence, enhancing transparency, and aligning executive compensation with long-term performance.
Furthermore, Japanese companies are becoming more aware of social and environmental issues, such as climate change and workforce diversity. The commitment to better governance and sustainable practices has likely made these companies more attractive to ESG-focused investors, contributing to the consistent outperformance of ESG funds in the Japanese market.
In the IA Global Sector ESG funds have shown steady outperformance over all three periods. Global diversification allowed ESG funds to benefit from regions adopting strong ESG practices while rising global demand for sustainability and lower risk profiles of ESG-focused companies contributed to better returns.
Our analysis of these seven sectors reveals that over 3 & 5 years, ESG funds outperformed the overall sector average in 4 of the 7 sectors analysed.
However, there are notable exceptions, such as the UK All Companies sector, where ESG funds consistently underperformed the sector average across all timeframes. Similarly, in the IA Europe Excluding UK sector, while ESG funds posted modestly higher growth averages over the recent 1 year period, they lagged behind the sector average of 3 & 5 years.
All Fund Performance Summary
We analysed the performance of all sector-classified Investment Association (IA) funds across different rating categories to assess how they compare within their respective sectors. his comprehensive analysis covers a total of 4,014 funds to understand how they compare within their sectors.
Among these funds, only 567 were awarded a high performance rating of 4 or 5 stars, with 349 funds achieving a 4-star rating and 218 attaining the highest 5-star rating. Meanwhile, 892 funds received a 3-star rating, indicating average performance.
However, approximately 63.7% of these funds underperformed relative to their peers. This significant portion of underperforming funds underscores the importance of careful selection and rigorous evaluation when making investment decisions within the IA fund categories.
Summary Performance Comparison Between ESG and Traditional Funds
As we analysed the comparative performance of ESG funds against all sector Investment Association (IA) funds across various rating categories, the data reveals notable disparities between the two groups.
Our analysis of the fund rating comparison between ESG funds and all sector Investment Association (IA) funds shows that, despite the increasing popularity and higher average returns of ESG funds, fewer of their funds receive a top performing 4 or 5 star rating compared to all other sector classified funds.
The 3 Pillars of ESG
ESG investing focuses on three key areas: Environmental, Social, and Governance, allowing investors to assess a company’s broader impact beyond financial performance. By evaluating how businesses manage environmental risks, social responsibilities, and corporate governance practices, ESG investing aims to promote sustainable growth while mitigating risks. This approach has gained significant traction among investors seeking not only returns but also long-term value aligned with ethical principles.
Environmental (E): Focuses on how a company impacts the planet. Key factors include carbon emissions, energy use, waste management, and water conservation. It assesses a company’s role in addressing environmental challenges.
Social (S): Examines how a company manages relationships with its employees, customers, and communities. This includes labour practices, diversity, human rights, and community engagement.
Governance (G): Involves a company’s internal systems and leadership. It looks at board structure, executive compensation, shareholder rights, and transparency, ensuring effective decision-making and legal compliance.
The Rise of ESG Investing
As of 2023, global assets in Environmental, Social, and Governance (ESG) investments have surpassed $40 trillion, with projections to reach $53 trillion by 2025, accounting for over a third of global assets under management (AUM). This rapid growth reflects increasing demand from investors and a shift by companies to integrate ESG criteria into their operations. In fact, Morgan Stanley's 2024 Sustainable Signals Study found that 85% of companies see sustainability as a driver of value creation.
ESG investing has now moved well beyond being a niche focus and is now a key strategy for many investors. With the rise of online tools for assessing fund performance and ESG ratings, it has never been easier to invest in high-quality funds that prioritise sustainability and ethical practices.
ESG has also become an essential factor in risk management. Companies with transparent ESG policies have shown greater agility and adaptability to modern work practices, positioning them better to handle emerging risks. This resilience is increasingly attractive to investors looking for stability in uncertain markets.
Globally, the demand for ESG-focused investments has surged. According to Morgan Stanley's 2024 Sustainable Signals report, sustainable funds attracted $6.6 billion in new investments in 2024. This represented a 24% increase compared to the previous year, highlighting the growing momentum behind sustainable investing.
According to the same survey, about 85% of investors now express interest in sustainable investing. This growing interest underscores the belief that integrating ESG factors into investment strategies not only aligns with ethical values but also enhances long-term growth prospects and risk mitigation.
As ESG continues to gain prominence, investors are increasingly recognising the dual benefits of achieving strong financial returns while contributing positively to society and the environment.
Investing in an ESG Strategy Makes Sense
Adopting an ESG strategy is increasingly recognised as a sound investment choice. Companies that embrace ethical practices towards their customers, employees, and the environment are often viewed as better long-term investments, reflecting stronger management and resilience.
ESG funds align with key global trends—like sustainability, demographic shifts, and technological innovation—that are poised for robust growth. This positioning makes them more attractive to investors, who are likely to remain invested during downturns and benefit from recoveries. Evidence from the Morgan Stanley Institute for Sustainable Investing shows that sustainable funds outperformed traditional ones and reduced risk during the 2020 coronavirus crisis, reinforcing their potential for strong financial returns alongside positive societal impact.
The reality is that Ethical and sustainable investing is no longer niche and should now be a consideration for growth-focused investors.
The outlook for funds with holdings in companies that have implemented ESG practices is brighter than those who have yet to make the move, which for investors provides some exciting opportunities for future growth.
In another sign that ESG investing is going to continue to grow exponentially, new plans by the Financial Conduct Authority (FCA) aimed at supporting the move to a low-carbon economy will require all UK-listed companies to tell investors all the climate risks they face. Such a requirement will force companies to up their game and will not only benefit the environment but it will also benefit investors.
ESG Investing With Yodelar
For years, many investors felt that investing in sustainable funds meant sacrificing growth - which was often the case. But in a short period of time the growing demand for ESG investing has been significant. The interest has now intensified to such an extent that it will now likely have a significant role in the future investment strategies for both fund manager and investor.
The role of ESG is rapidly growing, but there remains a limited number of high quality ESG portfolios on the market. As such, Yodelar Investments have created a range of risk rated ESG portfolios that provide investors with high quality, growth focused portfolios that adhere to the ESG framework as defined by industry leading investment research analysts, MSCI.
The development of our portfolios comes from years of research and analysis that included the consistent assessment of more than 100 fund managers, tens of thousands of funds and more than 30,000 investment portfolios.
Our investment approach ensures that the funds used to achieve the correct balance for each of our portfolios have consistently ranked among the best performers in their sectors. We believe this efficient and quality-based investment philosophy will help our ESG portfolios to excel and securely maximise the growth for our investors within a controlled ESG framework.
