Nuances in risk and sector exposures could have helped shield ESG funds from market downturns
As ESG investment hit its stride last year, many advisors and financial professionals remained skeptical of the space. One of the most common questions: “Can my client really afford to sacrifice broad market returns for the sake of sustainable investing?”
That criticism hasn’t aged well in recent months as ESG funds managed to perform relatively well amid the coronavirus chaos that punished financial markets.
Citing new figures from Morningstar, Pensions & Investments reported that 44% of all sustainable equity funds landed in the top quartile of their respective broad equity universes during the first quarter. Over the same period, 70% of those funds saw above-median performance within their equity universe.
Looking at ESG-focused U.S.-equity funds, Morningstar data showed 10 out of 12 outperforming the iShares Core S&P 500 ETF by 1.37 percentage points on average, net of fees. Meanwhile, all 11 ex-U.S. equity index ESG funds were able to perform better than the iShares Core MSCI EAFE ETF by an average of 1.89 percentage points.
ESG funds also saw robust inflows, with sustainable ETFs capturing a net total of US$7.8 billion, or 40% of all equity ETF flows, in the first three months of the year. And while the broad equity mutual fund segment suffered US$5.7 billion in net outflows, ESG mutual funds took in US$2.7 billion in net inflows.
Fans of ESG investing might point to often-cited factors such as the tendency for companies with high ESG scores to also exhibit hallmarks such as good management, solid fundamentals, or lower risk exposure. One important landmine that such firms may have sidestepped has to do with supply-chain transparency; those that refused to engage with Chinese suppliers over ESG concerns were vindicated as the country’s government shut down economic activity, causing a ripple effect that hit businesses globally.
A more obvious explanation, however, may stem from their lower exposure to the hard-hit energy sector. As noted by Pensions & Investments: “The S&P 500 Energy index lost more than 50% in the first quarter as the price of crude oil plummeted below $30 a barrel.”
While the iShares Core S&P 500 ETF and the iShares Core MSCI EAFE ETF had energy exposures of 2.6% and 4.2%, respectively, the top five funds in the U.S. and international categories had exposures averaging less than half of their group’s baseline fund.