‘It’s been the perfect storm’: when will there be a performance turnaround?

Sustainable investing - supporting businesses “doing good” - has come under pressure over the past couple of years on the back of higher interest rates and political headwinds.

Higher interest rates proved to be unfavourable for sustainable funds, as sustainable stocks are typically growth companies that have valuations based on the future profits.

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In terms of the political agenda the sustainable investments have under increasing pressure as US President Donald Trump thunders home his “drill, baby, drill” mantra, cuts funding for electric vehicles, bans offshore wind developments and describes diversity, equity and inclusion (DEI) programmes as being both “illegal and immoral”.

The green agenda has also somewhat shifted in the UK both from politicians and companies such as BP retreating from its renewable energy ambitions.

All the above are having a negative impact on sustainable funds.

‘Perfect storm’

“It’s been a perfect storm,” said Jake Moeller, associate director, Responsible Investment at Square Mile, the fund ratings and research firm. “We’ve had major concentration in the markets with the Magnificent Seven driving returns. A lot of sustainable funds consist of smaller to mid-sized caps, so that has been a bias which hasn’t worked,” he said. “There have also been headwinds for the type of companies that sustainable funds invest in with higher interest rates hitting longer-duration assets such as wind and solar. On top of that you have had the other headwind of Trump’s anti-ESG rhetoric.”

Tom Morris-Brown, portfolio specialist at Impax Environmental Markets Ord (LSE:IEM), agrees that concentration in areas such as artificial intelligence (AI) and defence post-Ukraine has been partly responsible for the challenges faced by sustainable funds in the past few years. “Higher interest rates have hit renewables,” he said. “Specific to IEM, with our heavy tilt towards industrials, we have seen supply chains take a long time to recover since Covid.”

Moeller added that this “noise” has not helped investor sentiment around sustainable funds. “It has been clouded by the over-exaggerated news flow and some investors may be looking at return options. Investors are examining their sustainable investments much more forensically than they have previously,” he said.

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Mike Appleby, a sustainable fund manager at Liontrust, said its sustainable equity funds such as Liontrust Sust Future Global Growth and Liontrust Sust Future UK Growth have lagged the MSCI and the Investor Association (IA) Global and UK not just over the last 12 month, but last three years.

He blames the three S’s. “The first is style, as we have quality growth companies. They are longer-duration assets trading on higher multiples, which were crushed when interest rates rose in 2022. The second is size, as we hold a number of mid-caps, which have struggled to keep up with mega-caps,” he said.

“The third is not owning stocks in sectors which did well post-Ukraine such as defence, oil and tobacco. We have a structural overweight in healthcare, particularly innovation and biotech. This has been a horror story since Covid as demand dropped, pricing came down and the sluggish Chinese economy hit sales.”

Trump is also a factor, but perhaps not as much as some think.

“Trump is diametrically opposed to everything we stand for,” he said. “We look for companies making our economy cleaner, healthier or safer. They are well managed with good business fundamentals, profitable within five years and undervalued. There is a misconception that we are up to our gunnels in renewables. We have less than 3% exposure in our global funds. Trump is unhelpful but it is not affecting our funds materially.”

Investor sentiment starting to turn?

In terms of investor sentiment, David Harrison, head of sustainability at Rathbones Asset Management, highlights a recent report from Morningstar which revealed that 54% of individual investors planned to increase their sustainable investments and that 77% were interested in sustainable investing.

“In terms of fund flows, we have had a very good year to date, although the second half of last year was challenging,” Harrison explained. “A positive trend for us has been the relative outperformance in Europe and the UK, where we have quite a big overweight position. We see attractive opportunities there, such as European industrials, from a sustainable and valuation point of view.”

Appleby also sees opportunities ahead. He notes: “We think those headwinds that we have faced will eventually normalise. We see an amazing investment opportunity right now in quality growth stocks. We see a growth in demand for their sustainable products and services. They also look really attractively valued.”

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He also mentions the outperformance of its Liontrust Sust Future Corporate Bond fund with mainstream peers. “Fixed-income funds have not suffered the three S’s. They are in bigger companies and have much less sensitivity to super-long duration assets,” he said. “There is a narrative that all sustainable investment is underperforming. Quite a lot of it is, but there are some areas continuing to deliver. Over the longer term if you take a 10-year period, then these funds are still very competitive with mainstream peers.”

One example is the Royal London Sustainable Leaders Trust, which over the last year (to 1 August 2025) has grown 6.6% compared with the 12.2% of its benchmark, the FTSE All-Share Index. However, over the last 10 years it is up 134.8% compared with the FTSE’s 94.1%.

George Crowdy, fund manager, explained: “Performance can be quite volatile over a 12-month period against the index. The last 12 months have been challenging to outperform because of the strength in the defence sector,” he said.

He agrees that sustainability as a sector is facing challenges. “Some traditional pockets which sustainable investors would have invested in such as renewable energy and electric vehicles have been difficult more for industry-specific reasons such as high interest rates and supply-chain challenges,” he said.

“We generally haven’t had that much exposure to that part of the market. We see an ongoing drive to make society more sustainable from a corporate perspective and in our individual lives. But there has to be a business case behind it, and you need to think about it on a five-year view. Structural growth trends are still intact.”

Shares the pros are backing

Appleby believes healthcare will come back as the NHS looks to innovation to make it more efficient. He highlights biotech company Intuitive Surgical Inc (NASDAQ:ISRG), which develops robotic surgery tools.

He also mentions Veralto Corp (NYSE:VLTO), which specialises in equipment used to monitor, manage and treat water. “It is a beneficiary of rising US capital expenditure in response to droughts and improving water management,” he said.

Also highlighted is UK stock Genuit Group (LSE:GEN), which provides sustainable water, climate and ventilation management solutions. “As weather events become more extreme, and urbanisation increases, Genuit is important in managing surface water to prevent flooding,” Appleby said. “We also like Halma (LSE:HLMA), which has a portfolio of companies focused on making our world cleaner, healthier and safer through their specialist products.”

Morris-Brown believes sector performance is already turning around. “First quarter was difficult for IEM, but the second quarter has been much stronger,” he said. “We are seeing market breadth improve, supply chains improve and M&A in renewables really ramp up. That’s down to attractive valuations.”

On sentiment, he said sustainability stock valuations became elevated during Covid when sustainability was one of the exciting trends. That has reversed and gone too far the other way.

“Those with a sustainable premium in 2021 are now trading at a discount to where they were before. They are in the penalty box, but they remain the same business. Sentiment is still low, but some investors believe it is time to take a closer look.”

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He highlights geothermal group Ormat Technologies Inc (NYSE:ORA), which is set to benefit from easier permitting and continued subsidies under Trump. It also helps to power data centres.

Harrison said there might be some “slight change of shape” but the themes of energy transition and decarbonisation remain strong. “Maybe it is more of a framing towards energy independence now,” he said. “Water infrastructure in every country needs improving for efficiency and we like the companies providing the solutions. Companies like Linde (NASDAQ:LIN) are also benefiting from an increase in demand for hydrogen.”

He also remains confident that attitudes to DEI have not shifted as much as feared. “We engage with companies on DEI. Underneath the bonnet we know that they recognise that it is still a crucial part of building culture and success,” Harrison said.

Moeller also remains optimistic. “Sustainable stocks are still supported by regulatory tailwinds and long-term consumer trends,” he says. “Renewables are becoming more cost competitive and cheaper than fossil fuels. Other reasons to still be excited are sustainable food opportunities and technology such as air conditioning as temperatures rise. Companies like Siemens AG (XETRA:SIE) are becoming the darlings of the sustainable world by capitalising on these long-term drivers.”