Do ESG funds really underperform traditional funds?

Do ESG Funds Really Underperform Traditional Funds?

In recent years, the investment landscape has been increasingly influenced by sustainability concerns, leading to a surge in interest in Environmental, Social, and Governance (ESG) funds. A common question among investors is whether ESG funds truly underperform their traditional counterparts. Let's delve into the data to clarify this issue and see how ESG funds have been performing in recent years.

Understanding ESG Fund Performance

Recent Performance Trends

Recent data suggests that ESG funds have generally kept pace with, and often surpassed, traditional funds. For instance, in 2023, sustainable funds achieved a median return of 12.6%, outperforming traditional funds, which recorded an 8.6% return. This trend continued into the first half of 2025, with sustainable funds delivering median returns of 12.5%, compared to 9.2% for traditional funds. This marks one of the strongest performances for ESG funds since 2019.

Sector and Asset💡 Definition:An asset is anything of value owned by an individual or entity, crucial for building wealth and financial security. Class Performance

Breaking it down further, ESG equity💡 Definition:Equity represents ownership in an asset, crucial for wealth building and financial security. funds returned 11.1% in the first half of 2025, outpacing traditional equity funds, which returned 10.2%. Notably, sustainable fixed income💡 Definition:A fixed-income investment where you loan money to a government or corporation in exchange for regular interest payments. funds saw a significant outperformance, with returns of 14.0% compared to a mere 4.8% for traditional fixed income funds. These numbers illustrate that ESG funds are not just keeping up but often leading in certain asset classes💡 Definition:A group of investments with similar behavior, risk, and regulatory profiles (e.g., stocks, bonds, cash)..

Real-World Examples and Scenarios

European Market Dynamics

In Europe, sustainable funds experienced a resurgence in inflows during Q2 2025 following a period of redemptions. This rebound was largely driven by regulatory clarity and strong market performance. Sustainable fixed income funds, particularly those with BBB credit ratings and global diversification💡 Definition:Spreading investments across different asset classes to reduce risk—the 'don't put all your eggs in one basket' principle., notably outperformed their traditional peers, leveraging regional performance differences and currency effects.

Thematic Investment Opportunities

Investors are increasingly looking toward ESG funds for exposure to growing investment themes such as climate adaptation, biodiversity, clean energy💡 Definition:Energy from sources that naturally replenish themselves and don't run out, such as solar, wind, and hydroelectric power., and emerging green technologies like green hydrogen and carbon capture. These themes are not only relevant in terms of sustainability but also present lucrative opportunities for future growth.

Considerations and Common Mistakes

Short-Term Volatility💡 Definition:How much an investment's price or returns bounce around over time—higher volatility means larger swings and higher risk. and Regulatory Challenges

While the performance trends are promising, ESG funds are not without risks. Investors should be mindful of potential short-term volatility and political or regulatory headwinds, which can impact fund performance. For instance, despite overall growth in ESG 💡 Definition:Total market value of investments managed by an advisor or fund. Used to calculate 1% annual advisor fees—$500K AUM = $5K/year.assets💡 Definition:Wealth is the accumulation of valuable resources, crucial for financial security and growth. under management reaching approximately $3.9 trillion by mid-2025, some funds faced net outflows in certain months due to these challenges.

Greenwashing Risks

Another critical consideration is the risk of greenwashing, where funds may claim to be sustainable without adhering to genuine ESG criteria. Investors should scrutinize fund disclosures and management practices to ensure alignment with true ESG principles. The increasing regulatory oversight, such as the European Securities and Markets Authority's guidelines, is helping to mitigate these risks by improving transparency and standardization.

Bottom Line

ESG funds have demonstrated strong performance relative to traditional funds, particularly in recent years. With median returns outpacing traditional funds in both equity and fixed income markets, ESG funds can no longer be dismissed as underperformers. However, investors should remain vigilant about fund-specific factors and evolving regulatory standards. By understanding these dynamics, investors can make informed decisions and potentially benefit from the growing trend toward sustainable investing💡 Definition:Investment criteria that evaluate companies based on environmental impact, social responsibility, and ethical governance practices..