The wave of investor enthusiasm for diversity-focused funds seems to be losing momentum. In 2024, global diversity funds recorded net outflows of $376 million, extending a decline that began in 2023 with a staggering $1.2 billion withdrawal.  This trend reflects a broader cooling toward ESG-themed investment vehicles as they face growing skepticism from investors due to concerns about underperformance, allegations of greenwashing, regulatory uncertainties, and shifting political ideologies. Once celebrated as a crucial element of responsible investing, diversity-focused funds now find themselves at a crossroads as investors reevaluate their priorities in an evolving economic and political landscape.

This article is written by Mourad Seghir ([email protected]) and Iman Zalinyan ([email protected]).  Mourad and Iman are part of RSM Netherlands Business Consulting Services, specifically focusing on Sustainability and Strategy.

The U.S. and European Divide: Political and Economic Pressures

The retreat from diversity investing has been particularly pronounced in the United States, where diversity-focused funds recorded outflows of $225.1 million in 2024—more than double the amount withdrawn the previous year. European diversity funds have also experienced declines, with net outflows totaling $138 million. This trend highlights a global reevaluation of diversity, equity, and inclusion (DE&I) investments, although the underlying causes vary across regions. In the U.S., the decline in investor appetite for DE&I-focused funds is linked to an ideological shift in political and corporate spheres. 

The rollback of federal diversity programs under the Trump administration set the stage for an anti-ESG movement that has gained traction in recent years. Critics argue that DE&I-driven investing is an ideological overreach, placing social issues above financial returns. This perspective has influenced legislative efforts across multiple U.S. states to restrict public pension funds from factoring ESG considerations into their investment decisions, creating a more challenging environment for asset managers to justify diversity-focused investments. Meanwhile, while the ideological pushback against ESG is less pronounced in Europe, regulatory uncertainty has played a more significant role in the retreat from diversity-focused funds. Evolving disclosure requirements have made it increasingly complex for fund managers to demonstrate the material impact of diversity-related investments. Concerns over potential greenwashing and inconsistent impact measurement have fueled investor skepticism, prompting some to exit these funds in favor of more traditional investment strategies.

Regulatory and Market Pressures: The Challenge of ESG Accountability

The decline in diversity-focused investing also coincides with increased scrutiny over ESG fund accountability. In both the U.S. and Europe, regulatory agencies have tightened disclosure requirements, demanding greater transparency in ESG fund reporting. While these measures aim to prevent misleading sustainability claims, they have also contributed to investor uncertainty. The risk of regulatory action or reputational damage from accusations of greenwashing has made some asset managers more cautious about promoting ESG-themed funds.  Moreover, the lack of standardized ESG impact measurement frameworks has created challenges for investors trying to assess the actual effectiveness of diversity-focused funds. Without clear metrics to show how these funds foster meaningful change in corporate DE&I policies, some investors have redirected their capital towards funds that promise more tangible, short-term financial returns.

Performance Concerns: Can Diversity Funds Compete?

Beyond political and regulatory pressures, concerns about performance have also fueled the retreat from diversity-focused investing. Like many ESG funds, diversity-focused investment vehicles have struggled to deliver strong returns, particularly during times of economic uncertainty. The downturn in technology stocks—many of which have led corporate DE&I efforts—has negatively impacted fund performance. With investors increasingly focusing on financial resilience amid market volatility, many have deprioritized investments, emphasizing social impact over profitability. 

Historically, proponents of diversity investing have pointed to research suggesting that companies with diverse leadership teams and inclusive corporate cultures tend to outperform their less diverse peers over the long term. While these findings remain compelling, they do not always align with the short-term return expectations of institutional investors who are pressured to optimize portfolio performance. Consequently, diversity-focused funds face an uphill battle in attracting and retaining investor confidence.

The Future of Diversity Investing: A Temporary Setback or a Structural Shift?

Despite the current downturn, some ESG advocates argue that diversity-focused investing is not a passing trend but a long-term strategy that will regain traction as market conditions stabilize and regulatory frameworks mature. They point to evidence that diverse companies benefit from improved decision-making, more significant innovation, and enhanced employee engagement—factors that could drive stronger financial performance in the long run.

Asset managers may need to refine their strategies for diversity-focused funds to regain investor trust. This could involve:

  • Enhancing Measurement Standards: Developing clearer, standardized frameworks to assess the impact of diversity investments, ensuring greater transparency and credibility.
  • Adapting Investment Models: Identifying new opportunities within diversity investing that align with financial returns, such as targeting sectors with high-growth potential and robust DE&I initiatives.
  • Strengthening Regulatory Alignment: Working closely with policymakers to establish ESG disclosure guidelines that provide both accountability and flexibility for investors.

Forward Thinking

The investor retreat from diversity-focused funds reflects a microcosm of the broader challenges facing ESG investing today. Once seen as the future of responsible capitalism, ESG strategies are now confronting resistance from shifting political ideologies, regulatory complexities, and market realities. The upcoming years will determine if diversity investing can endure these challenges and reclaim its role as a central element of sustainable finance. If diversity-focused funds can showcase social impact alongside competitive financial returns, they may re-emerge as a viable investment option. However, in the short term, trends indicate that financial performance, rather than social responsibility, will remain the dominant factor in investment decisions.

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