(Bloomberg) -- BNP Paribas Asset Management says ESG clients have been piling into money market funds, drawn by the allure of stable returns in cash-like instruments.

There’s “lots of cash” to move around and clients are reacting to “the volatility of the market in general,” said Thibault Malin, an investment specialist at the fund management arm of Europe’s biggest bank. 

The development coincides with an historic retreat from the more traditional ESG fund market, which has been plagued by lackluster returns. Combined with the uncertain outlook for global interest rates, ESG investors have been allocating an ever larger chunk of their money to low-volatility, highly liquid funds.

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At BNPP AM, assets in money market funds climbed 33% last year to just over €105 billion ($114 billion), with a further €5 billion of inflows in January, Malin said. The vast majority of that was new money going into 12 open-ended funds registered as Article 8, which means they promote environmental, social and governance goals under EU rules. 

“Investors are more comfortable with having more cash, and particularly with cash that pays much more today than it used to,” Malin said. 

The inversion of the yield curve — with rates on short-term bonds higher than those on longer-term debt — means that money market funds now “have more yield than you can offer on a 10-year German government bond,” he said. 

BNPP AM’s top-performing money market funds currently yield close to 3.8%, according to data compiled by Bloomberg. The current yield on Germany’s 10-year bond is about 2.5%.

The growing popularity of money funds among sustainable investors feeds into an ongoing debate around what can rightly be called ESG. Morningstar Inc., for example, doesn’t include money funds in its ESG analysis. The market researcher says the inclusion of such products in its data would “distort” the picture because of their cash-like nature. 

For its money funds, BNPP AM says it invests mostly in short-term debt issued by financial institutions with high ESG scores that are included in an ESG index. Among issuers whose securities are held in the asset manager’s funds are Barclays Plc, Credit Agricole SA, Sumitomo Mitsui Banking Corp., ING Groep NV and Standard Chartered Plc. Malin said that the average ESG score of the portfolio needs to be above that of its investment universe. 

“It’s actually been the second consecutive year where we continue to see inflows in money market funds over January,” Malin said. Less than 10% of the net new cash came from clients exiting positions in other products, he added. 

The wider investment industry is moving in the same direction. Globally, assets in money funds with an ESG label climbed 11% last year to $1.4 trillion, according to figures compiled by the Association for Financial Markets in Europe. The increase helped erase losses of as much as 32% in other ESG fund strategies and boosted the overall market by 8.7%, the data show. 

And while Morningstar data show that the global ESG market suffered its first outflows in the fourth quarter of last year, led by a US exodus, the picture looks different when money funds are included.

“We don’t expect major outflows in the year to come,” Malin said. 

Much of that is due to the outlook for interest rates, which BNPP AM sees staying higher for longer, adding to the appeal of cash-like instruments.

“We don’t believe there will be as many rate cuts as priced in by the market,” Malin said. “Investors are more comfortable with having more cash and particularly with cash that pays much more today than what it used to.”

However, the ESG commercial paper market remains dwarfed by other instruments carrying the label, and that represents “a big constraint” for how big the ESG money market can grow, he said.

“Clear guidance” on issuance is lacking, according to a January paper co-authored by Citigroup Inc. and the law firm Mayer Brown. As a result, 95% comes from companies that already have ESG-labeled debt. Still, offerings are likely to increase as “ESG factors are becoming more important in investors’ decision-making processes,” according to the paper.

--With assistance from Greg Ritchie.

(Adds research on commercial paper market in final paragraph.)

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