Can Sustainable Investing Recover from the Perfect Storm?

In 1991, a rare convergence of weather systems produced what became known as the “Perfect Storm” — not because any one factor was unprecedented, but because the combination created an outsized outcome.  The phrase has endured because it captures a familiar idea: when several forces converge at once, their combined effect can be far greater than any one of them alone.

This dynamic provides a useful frame for sustainable and mission-aligned equity performance in recent years. A number of market forces — including shifting style leadership, elevated market concentration, sector and geopolitical dynamics, and the challenges facing active management — have converged in ways that disproportionately affected many sustainability-oriented strategies. None of these forces alone fully explains recent performance and flows, but together they created a particularly difficult environment for many investors pursuing sustainability objectives.

In this investment perspective, we examine the key drivers of sustainable strategy performance in the U.S. equity market over the last several years and conclude with practical guidance for sustainably-minded investors navigating a rapidly evolving opportunity set.

Sustainable Investment Sentiment

Sustainable investing is now a relatively common approach among investors seeking to align portfolios with organizational values while pursuing competitive returns and societal benefits. Yet it is still frequently perceived as concessionary.

That perception is reflected in institutional sentiment. In the 2025 NACUBO-Commonfund Study of Endowments, 67.3% of respondents were
uncertain whether responsible investing can be a source of alpha, and nearly a third cited performance as a barrier to implementation¹.

At the same time, sustainable investing has continued to evolve in both scale and sophistication. What was once viewed as primarily values-based screening has widened to a broader investment discipline across public and private markets.

The U.S. SIF Trends Report 2025/2026 cites that sustainable investments make up $6.6 trillion out of the $61.7 trillion U.S. market. Although investors may be uncertain about sustainable investments’ ability to deliver outsized returns, it does not appear to deter investors’ appetite for sustainable investment strategies. Nearly 70% of survey respondents noted they remain committed to sustainability, many of whom emphasize financial materiality as a driving factor².

Performance Across Market Cycles

The performance of sustainable investment strategies is not a single continuous story; rather, it has moved through distinct environments.

For a multitude of reasons, sustainability funds had risen in popularity post COVID-19. But how popular were sustainability funds prior to peak interest?

Pre-COVID Performance

While data may be limited due to the small universe of sustainable mutual funds, assets under management had grown modestly until popular sentiment boosted flows in 2019.

Generally, there were no meaningful differences in performance between sustainable funds and their more traditional peers prior to COVID-19. Interestingly, sustainable funds appear to have performed better in periods of uncertainty, such as the 2008 financial crisis.

This may be due in part to a quality bias. Typically, sustainable funds avoid or underweight companies with weaker balance sheets, poor governance, and/or high regulatory risk, factors that may be favorable during weaker markets.  Overall, sustainable funds had generally performed in line with traditional peers in both domestic and international markets prior to 2020.

Passively managed funds tell a similar story; there also had been no return sacrifice with sustainability-oriented indices.

Benefited Performance: 2019–2021

Following the momentum of prior years, sustainable investment products surged in 2019-2020. During COVID-era conditions, markets favored growth-oriented equities—especially technology—alongside low rates, low inflation, and energy underperformance, benefiting many sustainability strategies.

Investor appetite for sustainable investment solutions was also high, supported by regulatory momentum and global net-zero commitments. Governments, corporations, and institutional investors announced ambitious climate targets, while expectations for increased clean energy investment, carbon reduction initiatives, and sustainable infrastructure spending contributed to strong market enthusiasm surrounding environmental themes.

Challenged Performance: 2022–2023

As rates rose and inflation accelerated, growth fell out of favor. The factor tilts often present in sustainability mandates, such as biases against traditional energy, became a headwind as energy reasserted itself in major indices. Higher rates also raised the cost of capital for capex-intensive renewables, putting pressure on parts of the clean energy complex.

Mixed Performance: 2024–Present  

The 2024–YTD 2026 period presented a mixed environment for sustainable investing strategies, shaped by: (1) a difficult backdrop for active management, (2) historically high market concentration, and (3) style environments that often ran counter to the quality-biased mandates that were embedded in many sustainability funds.

Drivers of Underperformance

From the post-COVID market environment to now, many actively managed sustainability strategies underperformed their benchmarks across regions and capitalizations. While the sources of underperformance were market-wide, they negatively impacted active sustainability strategies more than passively managed funds and many traditional strategies.

Reason 1: A narrow, concentrated market led by a handful of winners

Since 2023/2024, market concentration amongst U.S. equity markets remained a defining feature of equity returns, particularly among companies perceived to have dominant AI exposure. Mega-cap technology names drove a large share of gains, with a small group of leading companies accounting for a disproportionate contribution to overall index performance. Leadership remained concentrated in areas tied to AI investment, including communication services and information technology. This dynamic extended beyond U.S. equities, as international and emerging markets also saw performance fluctuations, but for different reasons.

By the end of 2025, the eight largest mega-cap growth stocks accounted for 45% of the Russell 3000 Index gains, despite those holdings representing one-third of the index’s market capitalization. As a result, most active strategies broadly struggled. According to Bloomberg, nearly three in four active large-cap mutual funds lagged in 2025, making it one of the worst years for active management since 2007, alongside continued outflows.

This degree of market concentration continues to be experienced today and, as a result, benchmark-relative outcomes are still heavily dependent on a small set of names. As of June 30, 2026, ten stocks were responsible for almost 70% of S&P 500 gains YTD, including four smaller constituents that have generated 100%+ gains.

For sustainable managers specifically, the challenge often intensified, as some of the dominant benchmark contributors were names that many sustainability frameworks underweight or exclude, creating structural relative headwinds in a narrow market. Governance, labor, and/or antitrust concerns barred many sustainable funds from select strong-performing names depending on the Fund’s mandate.

Reason 2: Style shocks, quality underperforms

In U.S. down-cap equities, style factors played an outsized role, with “quality” not rewarded – particularly after an April inflection (“Liberation Day”). There was a meaningful divergence between high- and low-quality cohorts that approached two standard deviations in magnitude.

Many sustainably-oriented managers focus on companies with positive earnings, but the present market environment has seen negative earnings segments of the market rewarded, particularly for companies speculated to benefit from AI.

Reason 3: Sector and geopolitical realities; energy, defense, and “bullets and bombs”

The underperformance narrative for sustainable strategies in international markets had a different flavor. Within EAFE, defense-linked industrials (“bullets and bombs”) were among the leaders, as European nations increased defense spending. These are market segments many sustainability managers avoid.

To put this into perspective, in Q4 2020, Aerospace and Defense was a minimal position in the EAFE index (1.2%) and contributed 46 bps to the index’s returns. By Q4 2022, rising geopolitical tensions from Russia’s invasion of Ukraine benefited global Aerospace and Defense names and drove its overall index exposure 29 bps above the year-end 2020 weight. By Q4 2025, the Aerospace and Defense sector soared even higher, delivering a return of nearly 78% over a one-year period, with an average weight of nearly 3.3% in the EAFE index. As of Q2 2026, Aerospace and Defense has maintained a position size of 3.3%.

Throughout this period, sustainability funds whose mandates prohibited investment in these companies struggled to deliver alpha.

Reason 4: Country effects in emerging markets

Country selection dominated sector/style effects in emerging markets in 2025. Korea and South Africa were notable outperformers. These countries have a limited set of names (Korea, often tech-heavy) or exposures (South Africa, mining-heavy) that many sustainability approaches may underweight or exclude.  Additionally, governance concerns often present themselves in these countries.

Reason 5: Passive vs active favorability

As investors seek to access equity markets in more cost-effective ways, including indexed sustainable strategies, inflows into actively managed funds have trailed passive funds. Overall, by December 31, 2025, passively managed assets grew to $19.4 trillion, while actively managed assets stood at $16.0 trillion.

This trend was also felt within sustainable equity strategies. Specifically, active sustainability-oriented funds saw net outflows of $22 billion in 2025.  Outflows have continued in U.S. markets in Q1 of 2026 for the 14^th consecutive quarter. Passive funds have not seen the same levels of outflows –experiencing in 2025 their first year of net annual inflows since 2022 (however, inflows were largely driven by one fund³). Through Q1 2026, passive strategies have continued to attract investor capital, experiencing nearly $3 billion of net inflows in the first three months of the year.

Modest outflows in U.S. active sustainable strategies began in Q2 2023 and have increased in subsequent quarters.

Despite recent outflows, U.S. sustainable fund AUM has not dropped significantly thanks to market appreciation.

Reason 6: The infrastructure reality of AI and power demand

The emergence of AI and data center enthusiasm has increased energy infrastructure needs, bringing renewed attention to energy and utilities as beneficiaries of electrification and power demand. Energy and utilities gained ground on the AI trade alongside political winds turning against clean energy/sustainability in general. This became most acute in Q2 2026 with the war in Iran and spiking oil prices, causing energy stocks to rise nearly 30% YTD.

Most sustainable funds have limited exposure to these companies or outright exclude them from the investment universe. However, renewables may play a significant role in the buildout of AI infrastructure. According to the International Energy Agency, renewables meet nearly half of the additional demand of data centers, with a projection of over 1,000 TWh in 2030 and 1,300 TWh in 2035 in the Base Case.

Is Sustainable Investing “Dead”?

The market environment from 2025 to the present has clarified several realities:

• The performance of sustainable strategies is cyclical and can be regime-dependent, similar to other investment styles.
• Constraints and exclusions can matter most when markets become narrow, concentrated, and sector-driven.
• Investor flows have been persistently negative in sustainability-dedicated active funds, reinforcing the need for careful manager/index selection and clear objective-setting.

Even with the increased backlash over the past several years, 70% of U.S. SIF Trends Report 2025/2026 survey respondents noted they expect to remain committed to sustainable investing. However, implementation has become more selective and outcome-focused. According to respondents, 46% anticipate they will focus on outcomes and positive impact alongside financial returns.

Where Mission Alignment Showed Resilience 

Even within a difficult period for many sustainability-dedicated equity strategies, there were bright spots. There was a notable reversal in clean energy, with the S&P Global Clean Energy Transition Index rising 46.8% throughout 2025 due to rising power demand and future growth expectations tied to electrification, onshoring of manufacturing, and data center expansion driven by AI/cloud adoption. This followed four straight years of underperformance from 2021–2024.  FY 2026 appears to have reinforced market support for clean energy. Through June 30, 2026, the Index returned nearly 59.4% YTD, despite the One Big Beautiful Bill’s phaseout of long-standing industry tax credits.

Moving Forward

The key lesson is that outcomes depend heavily on market regime, implementation choice, and clarity of objectives.

Passive Sustainable Funds Can Provide Market Exposure with Less Tracking Risk 

Passive sustainable investing can play a role as a market beta allocation with less idiosyncratic manager risk than active, but “ESG passive” is not monolithic. Different indices have materially different sector, factor, and exclusion profiles (e.g., fossil-fuel free vs. not), so investors must understand what exposures they are buying.

Be Aware of Active Manager Concentration 

Some investors may want to focus on active management, for returns and/or mission alignment reasons (like managers who actively file shareholder resolutions focused on sustainability).  These investors may consider well-diversified active strategies with lower tracking error to help mitigate the risk of being structurally “too different” from a concentrated benchmark, while still applying sustainability screens or engagement.   Alternatively, investors can look to appropriately size or pair certain managers with uncorrelated exposures that may also reduce overall tracking risk.

Start with Goals: Mission Outcomes, Risk Tolerance, and Implementation Fit 

The appropriate framework is to be explicit about desired outcomes:

• Are you targeting lower carbon intensity than a benchmark?
• Are you prioritizing support for certain corporate practices (labor, governance, diversity, etc.)?
• Do you want sustainability screens with minimal benchmark risk, or are you willing to tolerate larger deviations for specific impact objectives?
• Is active ownership and engagement central to your mission?

Prime Pathways is a way to translate mission alignment goals into an implementation plan.

Conclusion

Sustainable investing is likely to continue to evolve as it weathers political uncertainty, current events, and the desired non-financial investor outcomes. The specific nature of this evolution depends on the investors who want their capital to reflect mission and sustainability priorities, paired with the current events that shape those priorities.

Though sustainable investing has faced its share of turbulence—from shifting regulations to skepticism about its measurable impact—it has not capsized. Instead, it has adapted, recalibrated, and continued forward. Investors are learning not to avoid the storm, but to navigate through it. In doing so, sustainable investing is evolving as a framework for investors seeking to pursue long-term value in an uncertain climate.

 

¹ 2025 NACUBO-Commonfund Study of Endowments ² US SIF Trends Report 2025/2026 ³ Morningstar ⁴ International Energy Agency   All commentary contained within is the opinion of Prime Buchholz and is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer, to buy or sell securities.  The content of this report is current as of the date indicated and is subject to change without notice.  It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. For Morningstar output: © Morningstar 2026. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results. Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material, or guarantee the accuracy or completeness of any information herein, or make any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, it shall not have any liability or responsibility for injury or damages arising in connection therewith. 2025 NACUBO-Commonfund Study of Endowments © 2025 National Association of College and University Business Officers and Commonfund Institute. The 2025 Commonfund Study of Endowments is the product of a collaboration between NACUBO and Commonfund.   Data gathering for the study took place in the third and fourth quarters of calendar 2025 using an online survey instrument.  The respondents were the individuals knowledgeable about investment matters at participating colleges, universities and related foundations, and their answers to our questions provided the data that form the basis of this report.  An asset allocation worksheet was also completed by all Study participants.  The distribution of the 657 institutions across endowment size and institution type was designed to produce data that are statistically representative throughout the full sample.  This aspect of the research design supports the ability to benchmark foundations against true peers and enhances the stability of the data. Copyright MSCI 2026.  Unpublished.  All Rights Reserved.  This information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used to create any financial instruments or products or any indices.  This information is provided on an “as is” basis and the user of this information assumes the entire risk of any use it may make or permit to be made of this information.  Neither MSCI, any of its affiliates or any other person involved in or related to compiling, computing or creating this information makes any express or implied warranties or representations with respect to such information or the results to be obtained by the use thereof, and MSCI, its affiliates and each such other person hereby expressly disclaim all warranties (including, without limitation, all warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information.  Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any other person involved in or related to compiling, computing or creating this information have any liability for any direct, indirect, special, incidental, punitive, consequential or any other damages (including, without limitation, lost profits) even if notified of, or if it might otherwise have anticipated, the possibility of such damages. Information obtained from third-party sources is believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified.  Performance returns are provided by third-party data sources.  Past performance is not an indication of future results. Nothing herein should be construed as a guarantee of future results. © 2026 Prime Buchholz LLC