Lee Clements
Henry Morrison-Jones, CFA
- SI equities rebound: Sustainable equity indices recovered strongly in Q2, led by tech and energy efficiency, reversing Q1’s underperformance.
- Green bonds outperform: European-driven bond gains boosted green bond performance, supported by strong issuance.
- Adaptation finance rising: The climate adaptation market is growing fast - $1T in revenues and 21% annual growth - highlighting its growing investment appeal.
Q2 was another volatile period in broader financial markets. Initially, global equity markets fell, driven by global trade concerns following the announcement of US tariffs. However, this was followed by a strong recovery, driven by cyclical industries, with all regions showing strong performance.
Following a weak Q1 for sustainable investment (“SI”) performance, combined with outflows from SI-focused bond and equity funds, there was concern that further market volatility would lead to further SI underperformance. However, this was not the case. Despite the volatility in markets, sustainable investment indices saw a strong recovery during Q2, with SI equity and green bond performance picking up strongly and SI fund flows stabilising[1].
Q1 & Q2 relative performance of select global/developed SI indices
Source: LSEG FTSE Russell. Data as of June 30, 2025. Past Performance is no guarantee of future results
SI equity index performance
In SI equities, relative industry performance was a key driver. Technology, a key overweight position in SI indices, was up almost 23%, although the performance effect varied across different SI indices. The most consistently positive driver of relative performance was weakness in Energy, which is a key underweight in SI indices: weak energy demand and increasing oversupply led to falling oil prices[2], despite continuing geopolitical risk in the Middle East. The key outlier was the ESG Low Carbon index, which is more value-orientated: this was the only SI equity index underperformer in Q2 (while it had been the only outperformer in Q1).
Environmental Opportunities was the largest outperformer in Q2, more than compensating for the underperformance in Q1. The index also showed the best absolute performance amongst global SI indices over the 12 months ending June 2025. The index’s performance was driven by continuing strong performance from Energy Efficiency and a recovery in Renewable Energy. Recent data releases show that the energy transition continues to have strong momentum: clean energy investment is expected to hit a new high of $2.2 trillion in 2025, a level double that of the investment in fossil fuels[3]. Meanwhile, the rollout of electric vehicles also continues at pace, with 17 million vehicles sold in 2024, around 20% of all global vehicle sales (50% in China) and with Q1 2025 EV sales 35% up on sales in Q1 2024[4].
Adaptation measures disclosed across industries
Source: Investing in the green economy 2025: Navigating volatility and disruptions.
However, with the trajectory of carbon emissions still below that required to achieve net zero by 2050 and temperatures continuing to rise, the risk from physical climate change continues to increase. Investors need to be aware of this risk, which could impact equities and sovereign issuers alike, reflecting a rising rate of natural disasters. One key result of rising physical climate change risk is the development of the climate adaptation solutions market. This market is already estimated at around $1 trillion of green revenues and has grown at a 21% annual rate over the last four years. A global analysis of the climate-related disclosures of large- and mid-sized companies show that 34% are implementing adaption-related measures, although with sharp differences between sectors. Over a quarter of the green bonds in issue also involve adaptation in their use of proceeds[5].
SI fixed income index performance
Green bonds were the other key area of outperformance in Q2, with both corporate and sovereign green bond indices outperforming their reference benchmarks. The main driver for the outperformance was the overweight position in European bonds and the underweight position in US bonds in both indices: this benefited performance as European yields fell more rapidly in Q2 than US yields. Green bonds also saw strong issuance in Q2, with this category representing an increasing proportion of bonds issued.
Sustainable fixed income is an area of significant importance and represents the key source of capital for the energy transition. Investors also continue to roll out sustainable fixed income investments, with cumulative flows into SI-focused bond funds stronger than those into SI equity funds over the last two years. However, the drivers for sustainability in fixed income differ from those in equities, since they are largely focused on risk mitigation and the lowering of volatility . One potential area of risk is carbon-intensive debt, which represents the second-largest sector in outstanding corporate debt (after Financials), with large volumes of carbon-intensive corporate debt due to mature in the next five years. Historically, Energy sector corporate debt has seen credit spreads increase in times of falling oil prices and reduce in times of rising oil prices. However, over the last 10 years falling oil prices have had a greater effect on corporate spreads and rising oil prices have had a lower effect (see the chart), indicating that investors may be more risk averse to Energy sector bonds. In summary, there may be an increased overall risk to bond investors during the current period of weak oil prices, reflecting increased refinancing risks[6].
Spread of Energy sector corporate bonds vs oil price
Source: Spread between yield of GLICs Energy sector investment grade corporate issuers in the WorldBIG Corporate index vs the yield of the overall WorldBIG Corporate index vs Brent oil price
The Q2 recovery in SI indices was mirrored by a rebound in SI fund flows, according to data from Lipper. After two of the weakest months for SI bond and equity fund flows in March and April 2025, May and June saw flows recover, driven by SI bonds, SI passives, Canada and certain European countries.
SI vs Market bond and equity fund flow
Source: LSEG Lipper SI focused bond and equity ETFs and mutual funds estimated fund flow
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