The first quarter of 2025 delivered a stark message to the ESG investing world: the era of broad promises may be over.

A recent report from Morningstar, revealed that global sustainability funds endured their “worst quarter on record,” registering net outflows of a staggering $8.6 billion. This sharp reversal from previous quarters, particularly the $18.1 billion in inflows seen in Q4 2024, signals a period of profound uncertainty and heightened scrutiny for the sector.

Perhaps most notably, Europe – long considered the most stable and progressive market for ESG investments – experienced its first quarter of net outflows since Morningstar began tracking this data in 2018. European sustainable funds collectively saw $1.2 billion withdrawn, a striking contrast to the $20.4 billion in restated inflows in the final quarter of 2024. This significant shift suggests that the headwinds faced by ESG investing, which have impacted the US for ten consecutive quarters of outflows (reaching $6.1 billion in Q1 2025), are now more broadly affecting global sentiment.

Anti-ESG backlash

Several interconnected factors are contributing to this dramatic downturn, pointing to what some commentators have termed a “more demanding phase” for ESG.

Firstly, a growing “anti-ESG backlash,” particularly amplified by political shifts in the United States, appears to be crossing the Atlantic. The return of a US administration perceived as less supportive of climate and diversity initiatives has emboldened critics and created a climate of uncertainty, prompting investors globally to re-evaluate their ESG allocations. This has led to concerns about potential financial and legal repercussions for companies heavily invested in ESG-labeled activities states the report.

Secondly, performance concerns are weighing heavily on investor sentiment. Many ESG portfolios, particularly those heavily weighted in sectors like clean energy, have underperformed in recent quarters. Investors, seeking more stable or traditionally lucrative investments amidst a complex geopolitical and economic environment, are naturally shifting capital. While sustainable bond funds did see some inflows in Q1 2025, the report noted that redemptions from equity and allocation funds significantly outstripped them.

ESMA naming regulations

Thirdly, the evolving regulatory landscape and concerns over “greenwashing” are playing a critical role. Stricter EU fund naming regulations, such as ESMA’s new rules (CDR (EU) 2020/1818), coming into full effect for existing funds in May 21, 2025, have prompted significant rebranding activity.

Morningstar reported that 335 European funds with ESG-related terms in their names rebranded in Q1 2025, with 116 notably dropping ESG-related language altogether. This reflects asset managers’ increased caution and desire to avoid accusations of misrepresenting their funds’ sustainability credentials. The slowdown in new sustainable fund launches also points to a more cautious approach to product development in response to these regulatory pressures.

Outlook

Despite the record outflows, the total assets in the global ESG fund universe remain substantial, standing at $3.16 trillion at the end of March. However, as Hortense Bioy, head of Sustainable Investing Research at Morningstar Sustainalytics, notes, “Investor appetite for ESG funds will continue to be tested in the months ahead by an evolving regulatory landscape and mounting geopolitical tensions.”

Investors and regulators are increasingly seeking clear, measurable actions and demonstrable impact. The current challenging environment may well serve as a catalyst, pushing the ESG market towards greater transparency, stricter accountability, and a more robust foundation for sustainable investing in the long term.