Has Trump 2.0 brought a regime change for sustainable investing?

Investing.com -- Sustainable investing is facing a structural reset under the second Trump administration, with changing policy priorities and investor sentiment challenging the ESG narrative that gained momentum during the previous decade.

“Trump 2.0 has brought about a regime change for sustainable investing,” Barclays (LON:BARC) strategists said in a note, as valuation premiums for ESG stocks unwind and global ESG equity funds post their first annual outflows in 2024.

This pullback is not driven by earnings fundamentals. Barclays points out that "EPS momentum for ESG names is actually improving compared to broader equity peers," indicating that investor retreat is more a reflection of political and regulatory headwinds than corporate underperformance.

At the same time, global equities overall continued to attract inflows, suggesting that “issues might be idiosyncratic to sustainable investing and its policy path,” strategists noted.

While the U.S. outlook for ESG remains clouded by deregulatory moves and a renewed focus on fossil fuels, Europe may be entering a new phase of pragmatism.

Policymakers are moving toward less rigid ESG frameworks that prioritize competitiveness, energy security, and defense.

Barclays notes the EU’s Clean Industrial Deal and Omnibus proposals as examples of this evolution, suggesting that “a move towards a simpler, consistent and comparable regulatory regime going forward will help draw more capital back to ESG funds and aid their performance.”

This more flexible stance could have significant implications for capital flows. ESG mandates have traditionally excluded entire sectors, including defense and energy, limiting portfolio diversification and raising capital costs for companies in those industries.

But the report observes that transition funds—which apply ESG principles without strict exclusions—are gaining ground. These funds have shown more stable inflows and may serve as a bridge between sustainability goals and strategic policy shifts.

Defense, in particular, is emerging as a potential beneficiary. ESG funds are starting to soften their stance, and underweights in defense-exposed stocks have decreased. Simultaneously, the average exposure of ESG funds to the Aerospace and Defence sector has jumped over time.

“This could unlock more pent-up demand for investment into the space, in our view,” strategists added.

Europe’s equity markets, which have a far higher penetration of ESG mandates than the U.S., could also benefit from a rebalancing.

Roughly 20% of European equity assets are ESG-linked compared to just 2% in the U.S. If EU regulations continue to ease and fiscal support strengthens, capital may return to previously excluded sectors such as infrastructure, materials, and defense.