The landscape of Environmental, Social, and Governance (ESG) initiatives is currently navigating a period of unprecedented turbulence and widespread criticism. This era, characterised by significant capital outflows from sustainable funds and intense scrutiny of corporate sustainability claims, has led many observers to question the fundamental viability and efficacy of ESG. However, as Kendall Reid argues, a deeper analysis reveals that this backlash, far from signalling the demise of sustainable finance, represents a crucial and ultimately beneficial market correction.
The fading golden era and exhausted easy wins
The recent turbulence in the ESG market is best understood as an inevitable correction, a necessary recalibration following a period of rapid, and sometimes unchecked, expansion. The initial enthusiasm for ESG, often dubbed a "golden era," was fuelled by readily accessible gains that, while real, proved unsustainable in the long term.
The early adoption of ESG saw a surge in interest and capital inflows, partly driven by the perception of consistent outperformance by sustainable funds. Over a five-year period, sustainable funds achieved a median performance that was 4.7% higher than traditional funds, with a 4% lead in 2023 alone. The Covid pandemic in particular, was seen as a "golden era" for ESG funds, where they outperformed traditional indices. These early successes often stemmed from what can be described as "low-hanging fruit"—straightforward efficiency gains, such as reduced energy consumption leading to cost savings, and effective "green marketing" campaigns that boosted sales and brand reputation.
The initial outperformance, while genuine for a time, was tied to specific, easily captured benefits that, once fully exploited, could not sustain the same level of market advantage.”
However, the market dynamics began to shift as these initial opportunities became exhausted. The performance lead of sustainable funds narrowed significantly, dropping to just 0.6% in the first half of 2024. This diminishing return indicates that the market is now demanding more than superficial improvements; it requires ESG initiatives to contribute to long-term, sustainable financial performance, pushing for a more rigorous assessment of value. The initial outperformance, while genuine for a time, was tied to specific, easily captured benefits that, once fully exploited, could not sustain the same level of market advantage. This signals a critical need for ESG to move beyond these initial, easily captured benefits and demonstrate deeper, more enduring financial value.
Record capital outflows: A global reassessment
The most tangible manifestation of this market correction has been the unprecedented capital withdrawals from sustainable investment funds. This trend is not merely a political backlash propelled by the US administration nor does it signify a sudden lack of concern for sustainability among investors. Instead, it reflects a sober and widespread financial reassessment.
Global sustainable investment funds experienced record outflows of approximately $8.6 billion in the first quarter of 2025, a sharp reversal from the over $18 billion of net inflows recorded in the final quarter of 2024. Crucially, this phenomenon is not confined to the U.S. market. For the first time since at least 2018, European sustainable funds recorded net redemptions, with $1.2 billion in outflows in Q1 2025, even as their conventional counterparts continued to attract strong inflows. While U.S. outflows reached $6.1 billion in the same quarter, the European trend underscores that this is a global re-evaluation driven by fundamental financial considerations, rather than being solely an ideological or politically charged movement. The issue is systemic and financial, compelling a more universal and robust approach to ESG.
The true drivers: Financial underperformance and cost burden
Since 2022, ESG funds have faced the hard reality of ESG relative underperformance compared to traditional equities. This underperformance is largely attributable to the structural biases embedded within many ESG indices and funds. These portfolios often held a higher proportion of technology companies while being underweight or excluding sectors like fossil fuels, materials, commodities, and defence. This composition proved detrimental when macroeconomic conditions shifted. Following the Russia-Ukraine war, energy commodity benchmarks soared, and defence sector stocks performed exceptionally well, benefiting sectors typically excluded or underweighted by ESG funds. Simultaneously, the plummeting of Big Tech stocks in 2022 further exacerbated the underperformance of ESG leaders. This structural vulnerability, prioritising certain exclusions over diversified financial resilience, exposed a critical flaw in the construction of early ESG funds. Some studies even indicated that high sustainability funds did not outperform their lowest-rated counterparts, and "responsible investors" experienced reduced financial returns. The backlash, therefore, compels a re-evaluation of how ESG principles are applied to portfolio construction to ensure financial viability and adaptability to changing market conditions.
These portfolios often held a higher proportion of technology companies while being underweight or excluding sectors like fossil fuels, materials, commodities, and defence.”
The market's unwavering demand for returns
A fundamental principle of investing is the generation of returns. The recent backlash serves as a stark reminder that while ethical and societal considerations are increasingly valued, they must ultimately align with, or demonstrably enhance, financial performance. The core role of investors has always been, and continues to be, to generate returns, whether over a short or long- time horizon, depending on their mandate.
The market's response is a powerful signal: when ESG principles, such as avoiding fossil fuels, directly conflict with market performance, investors will prioritise their mandates for returns, as is their fiduciary duty to shareholders”
Many, including proponents of the anti-ESG movement, often argue that ESG strategies conflict with company directors' fiduciary duties to maximise shareholder returns, and in many cases, they are right. This perspective, while sometimes politically charged, underscores a core expectation within the investment community. The underperformance of ESG funds, particularly when traditional investments in "non-ESG" sectors yielded strong returns, created a direct tension with this fiduciary duty. The market's response is a powerful signal: when ESG principles, such as avoiding fossil fuels, directly conflict with market performance, investors will prioritise their mandates for returns, as is their fiduciary duty to shareholders. This is not a sudden shift towards indifference but a fundamental aspect of investment decision-making. The current market correction is therefore forcing ESG to prove its financial materiality and its contribution to shareholder value, rather than being perceived as a separate, potentially concessionary, investment category. This pressure for financial returns is a powerful (and necessary) force, compelling ESG to evolve into a more pragmatic, financially integrated, and value-driven approach that aligns with, rather than detracts from, investor mandates.
ESG’s early years
In many ways, ESG (or ‘Corporate Responsibility’, as it was often known as in the 1990s) started on a much more realistic path. The few practitioners who were early adopters of ESG quickly realised that ESG needed to be commercial, that any projects needed to show a clear and measurable return on investment, that outcomes and impacts were key, and there needed to be bang for buck. Biproducts of good ESG programmes should always be accounted for (and designed into scope where possible) – things like efficiencies maximisation and operational improvements that generally come with programmes such as decarbonisation or governance improvements, for example, should priced in and the benefits calculated. ESG should become a central part of business function – not a standalone, siloed practice, but something that was used as a tool across business units to drive cost savings, create measurable impact and improve outcomes for a variety of stakeholders.
Where it went wrong – the measurement trap
Along the way, the ESG market lost sight of what was important – impacts, commerciality and material returns (whether they be economic, social or environmental) and instead prioritised external ratings and investor optics over genuine, fundamental business resilience and long-term value creation. This often led to a "checkbox exercise" mentality, where companies focused on what would "look good in the next report" rather than what would truly create resilience and long-term value. ESG was frequently criticised as being "just a PR move" and failing to deliver "meaningful impact on society or the environment".
This focus on optics created a "measurement trap." The process of achieving a favourable rating, often based on self-reported data, became an end in itself, rather than a means to achieve genuine sustainability outcomes. The lack of standardised measurement for ESG success further exacerbated this problem, with various agencies offering bespoke rating systems that could yield significantly different and often contradictory results for the same companies. This inconsistency opened ESG claims to widespread scrutiny and scepticism, leading to a significant erosion of trust.
Challenges with data quality, self-reporting, and standardisation
The reliability of ESG data has been a persistent and fundamental concern, undermining the objectivity and utility of ESG ratings. This issue stems from several critical weaknesses in the data infrastructure. A primary criticism is the heavy reliance on self-reported data from the companies being rated. This allows companies the freedom to selectively publicise information and offer their own interpretations, potentially inflating their scores and making them appear more ESG-conscious than they actually are. In many cases this self-reported data does not account for ESG risks that have bottom-line compliance, financial, and reputational impacts
Furthermore, a major criticism is often the absence of legal requirements for ESG data to be audited, making it exceedingly difficult to verify claims, identify omissions, or detect inaccuracies within sustainability reports. ESG rating agencies also frequently utilise data from third-party sources, which may not accurately reflect a company's actual efforts or performance. The lack of consistent global reporting and auditing standards, coupled with variations in definitions and methodologies among ESG rating providers, leads to significant inconsistencies and even contradictory ESG scores for the same companies. This systemic lack of reliable, verifiable data and the resulting greenwashing erode investor and consumer confidence in the entire ESG framework. The current scrutiny is compelling regulators to introduce stricter disclosure rules, such as the EU's Sustainable Finance Disclosure Regulation (SFDR), and is pushing for greater transparency and accountability.
The reset
Ironically, the retreat from ESG may be ESG’s best chance to evolve and save itself.
Now is the time for companies to begin to ask better questions:
- What are the long-term risks to our business model?
- Where are the opportunities to future-proof our operations?
- How can we create value that is both sustainable and strategic?
This shift is already happening. Impact investing—especially in focused sectors like clean energy, agriculture, healthcare, AI, and education—is thriving. These are investments where outcomes can be measured and value creation is tangible. It’s not about labels or scores; it’s about results.
The backlash, while challenging, is serving as a powerful crucible, forging a more resilient and financially rigorous approach to sustainable business.”
The backlash, while challenging, is serving as a powerful crucible, forging a more resilient and financially rigorous approach to sustainable business. This period is compelling a fundamental redefinition of value, shifting ESG from a mere compliance checklist to a strategic imperative.
The shift towards financial materiality and rigour
The current market correction is compelling companies to adopt a more sensible and commercial approach, focusing on ESG factors that are financially material and contribute directly to core business fundamentals. The concept of "financial materiality," or "outside-in materiality," emphasises the impact of external environmental and social factors on an entity's financial performance and risk profile.
Investors are now demanding meaningful information in order to fully understand how specific ESG factors affect portfolio performance and returns within given sectors. This signifies a crucial evolution from a broad, often vague ESG approach to a precise, analytical framework that identifies specific risks and opportunities linked to a company's bottom line. The negative noise around ESG is highlighting the imperative to move beyond virtue-signalling and establish concrete links between ESG, strategy and tangible deliverables that drive value, such as energy efficiency, supply chain innovation and the strategic use of AI. Companies that effectively operationalise ESG principles and embed them into their business model and financial systems will not only be better positioned to minimise risks but will also gain a distinct market advantage. This shift is transforming ESG into a more robust, data-driven discipline, where investments are justified by their measurable contribution to business fundamentals and financial resilience, rather than solely by reputational benefits.
Strategic rebranding: Beyond the "ESG" acronym
A notable response to the backlash has been a strategic shift in corporate communication: many companies are de-emphasising or entirely dropping the "ESG" label from their public-facing materials. This trend involves adopting terms like "sustainability," "impact," or "responsible business practices" as alternative positioning. The share of S&P 100 companies using "ESG" in their annual sustainability report titles plummeted from 40% in 2023 to just 6% in 2025. Similarly, fund rebranding reached a new high in Q1 2025, with 116 funds specifically dropping ESG terms from their names.
Many companies are de-emphasising or entirely dropping the "ESG" label from their public-facing materials.”
Crucially, this terminology shift does not signify that companies are abandoning underlying commitments. Instead, this rebranding represents a strategic move to depoliticise their efforts and focus on the substantive actions and outcomes, rather than a loaded acronym that has become a target for ideological criticism. This suggests a maturation in how sustainability is communicated, emphasising tangible actions and intrinsic value rather than relying on a potentially tarnished label. The backlash is fostering a more authentic and less performative communication strategy, which could lead to more substantive and less contentious engagement with sustainability initiatives.
The rise of targeted, outcome-driven impact investing
The limitations exposed in broad ESG approaches are accelerating the adoption of a more precise and powerful form of sustainable finance: impact investing. While ESG is primarily understood as a framework for assessing risks and opportunities that may materially affect a firm's sustainability, impact investing is an investment strategy explicitly designed to drive positive, measurable social and/or environmental outcomes alongside financial returns.
Impact investing inherently focuses on demonstrable change.”
A core principle of impact investing is "intentionality"—an explicit aim to generate a specific outcome from investments. This forward-looking approach prioritises measurable impact, transparency, and accountability. Unlike some traditional ESG applications that might be criticised as checkbox exercises or for lacking meaningful impact, impact investing inherently focuses on demonstrable change. While all impact funds typically consider ESG factors, not all ESG funds are focused on generating direct impact. This clear differentiation allows for greater clarity in investment objectives and a more direct pathway to verifiable progress. The backlash, by exposing the limitations of broad ESG, is accelerating this transition to precise, outcome-focused impact investing, which offers a clearer value proposition and greater accountability for real-world change, making sustainable finance more credible and attractive to discerning investors.
Sustainability as a strategic opportunity for business resilience
Perhaps the most profound benefit of the current ESG reckoning is its potential to free companies from the pressure of merely chasing ratings for next year's report. Instead, it empowers them to truly rethink their approach and treat sustainability as a strategic opportunity—a way to build real, resilient, and future-proof businesses.
Resilience is emerging as a key factor across all facets of business operations and strategy, extending beyond just climate concerns. Companies that operationalise ESG principles and embed them deeply into their business models and financial systems are not only better positioned to minimise risks but also gain a significant market advantage. The focus is shifting towards concentrating on sustainability as a fundamental driver of business value, innovation, and long-term resilience. Businesses that invest for the future, rather than pulling back in response to current pressures, will be rewarded as societal and environmental conditions continue to change. The backlash, by exposing superficiality and forcing a re-evaluation, is compelling companies to genuinely embed sustainability as a core strategic pillar. This deep integration leads to greater long-term resilience, innovation, and competitive edge.
Conclusion: A More Robust and Credible Path Forward for ESG
The recent backlash against ESG, characterised by capital outflows, financial underperformance, and intense scrutiny of implementation flaws, is not a harbinger of its demise. Instead, it represents a pivotal and ultimately beneficial market correction.
The challenges have exposed critical weaknesses: the illusion of sustained outperformance from easy wins, the systemic trust deficit caused by greenwashing and poor data quality, the pervasive competence gap within organisations, and the disruptive politicisation of the ESG acronym. These exposures are forcing the market to mature. Investors are reasserting their primary mandate for returns, demanding that ESG initiatives demonstrably contribute to, rather than detract from, financial performance. This pressure is driving a more rigorous assessment of financial materiality, pushing companies to identify and invest in sustainability efforts that yield clear, quantifiable returns and enhance long-term business resilience.
Furthermore, the backlash is catalysing a strategic rebranding, moving away from the politically charged "ESG" label towards more substantive labels like "sustainability" and "responsible business practices." This shift is not an abandonment of commitments but a signal of deeper authenticity, focusing on tangible actions and outcomes. Crucially, it is accelerating the evolution towards targeted, outcome-driven impact investing, where capital is intentionally deployed to generate measurable positive social and environmental benefits alongside financial returns. This specialised approach offers a more transparent and accountable pathway to real-world change.
The turbulence surrounding ESG should not be mistaken for collapse but recognised as a necessary reset. The unwinding of inflated expectations, the exposure of weak data foundations, and the retreat from cosmetic reporting are clearing the path for a more disciplined, transparent, and resilient approach to sustainable finance. Far from signalling retreat, this moment is an opportunity for companies and investors alike to rediscover the fundamentals: value creation, risk management, and long-term resilience.
