ETF Liquidation and Strategic Portfolio Adjustments in ESG Equity Strategies

Franklin Templeton’s decision to liquidate its Sustainable International Equity ETF (MCSE) by January 16, 2026, marks a pivotal moment in the evolution of ESG-focused investment strategies. This move, announced on September 8, 2025, reflects broader industry challenges and strategic recalibrations within the ESG ETF landscape. For investors and asset allocators, the dissolution of MCSE underscores the need to critically evaluate the performance, regulatory risks, and structural shifts shaping ESG equity strategies in 2026 and beyond.

Performance Pressures and ESG ETF Challenges

The MCSE ETF, which reported a -9.22% return before taxes and -9.31% after taxes for its most recent period, exemplifies the performance hurdles faced by ESG ETFs. These figures, detailed in the fund’s SEC filings [2], highlight the tension between ESG integration and financial returns. While passive ESG ETFs demonstrated resilience during economic stress in 2019–2020—outperforming S&P 500 benchmarks by 5.25% annually [6]—their long-term underperformance against non-ESG counterparts has raised questions about their viability. Franklin’s liquidation of MCSE aligns with a broader trend: over 30% of European ESG funds rebranded or abandoned ESG terminology in 2025 to comply with anti-greenwashing regulations, signaling a shift toward more transparent, niche strategies [3].

Regulatory Scrutiny and Strategic Reallocation

Regulatory pressures have intensified for ESG ETFs, particularly in the U.S. and Europe. The return of Trump-era policies, including the rollback of ESG regulations and potential withdrawal from the Paris Agreement, has created legal and financial uncertainties [2]. In Europe, the Sustainable Finance Disclosure Regulation (SFDR) and Corporate Sustainability Reporting Directive (CSRD) have forced providers to refine methodologies and avoid vague sustainability claims [2]. Franklin’s decision to liquidate MCSE may reflect a strategic pivot to align with these evolving standards, prioritizing compliance and investor clarity over passive ESG indexing.

The Rise of Active ESG Strategies

The liquidation of MCSE also highlights the industry’s growing preference for active management. As of 2025, 60% of global ETF launches were active strategies, up from 13% in 2019 [4], driven by investor demand for differentiated performance and lower fees compared to traditional active funds. Active ESG ETFs, in particular, are gaining traction as they seek to exploit niche opportunities in sustainability-linked sectors. This shift is supported by data showing that active ETFs captured 20% of 2023 net flows despite representing less than 10% of assets under management [5]. Franklin’s move may signal a broader reallocation of resources toward active strategies, which offer greater flexibility in navigating regulatory and market volatility.

Implications for ESG Investors in 2026

For ESG-focused investors, the dissolution of MCSE underscores the importance of diversification and due diligence. Passive ESG ETFs, while cost-effective, face headwinds from performance consistency and regulatory scrutiny. Active strategies, though not immune to underperformance—73% of international small-cap funds underperform benchmarks over 20 years [2]—offer potential for innovation in portfolio construction. Investors must weigh these trade-offs while prioritizing transparency in ESG methodologies.

Moreover, the integration of ESG principles into mainstream portfolios is likely to accelerate. PwC’s 2026 outlook notes that 45% of ETF providers expect over half their launches to be ESG-focused, reflecting heightened stakeholder expectations [1]. This trend will require asset allocators to adopt dynamic, diversified strategies that balance financial returns with sustainability goals.

Conclusion

Franklin Templeton’s liquidation of the Sustainable International Equity ETF is emblematic of a sector in flux. While ESG ETFs face performance and regulatory challenges, the rise of active strategies and investor demand for innovation present opportunities for reinvention. As 2026 unfolds, ESG-focused investors must navigate this evolving landscape with a dual focus on compliance and performance, leveraging active, diversified approaches to align with both financial and sustainability objectives.

Source:
[1] ETFs 2026: The next big leap [https://www.pwc.com/gx/en/industries/financial-services/publications/etf-2026-the-next-big-leap.html]
[2] Investors Turn Away from ESG Funds in Record Numbers [https://global.morningstar.com/en-gb/sustainable-investing/investors-turn-away-esg-funds-record-numbers-q1-2025]
[3] 10 key takeaways from the Trackinsight Global ETF Survey 2025 [https://informaconnect.com/10-key-takeaways-from-the-trackinsight-global-etf-survey-2025/]
[4] Hidden Gem or Fool’s Gold: Can passive ESG ETFs [https://www.sciencedirect.com/science/article/abs/pii/S105752192300056X]
[5] The Active ETF State of Play: A Worldview of the Growing [https://www.irishfunds.ie/news-knowledge/newsletter/the-active-etf-state-of-play-a-worldview-of-the-growing-trend/]