ESG investors forced to recognize surging oil stocks

Energy's spectacular outperformance heaps pressure on sustainable funds

ESG investors forced to recognize surging oil stocks

‘Do-good’ investors are licking their wounds and facing up to what many believe is a stark reality – oil and gas stocks are too good to ignore.

More investors are upping their exposure to oil and gas producers because of the energy sector's performance, while the sector's weighting in the S&P 500 has increased by 71% over the past year.

With a 135% increase in 2021 and 2022 compared to the S&P 500 Index's 2.2% rise, the energy sector has topped the stock market over the past two years. Despite its 5.8% fall so far, Wall Street experts predict the industry will increase by another 22% in 2023 and once again outperform the general market.

The result is that even the most vociferous  ESG backers are taking on more energy exposure. According to Financial Advisor, Rockefeller Capital Management, a company that takes great pride in its ESG investing record, which its $10.4-billion asset management division pursues, now gas a 6% energy weighting in its $19 billion equity portfolio, compared to the S&P 500’s 4.8%

Professor Shivaram Rajgopal at Columbia Business School claims that fund managers who underweighted energy and underperformed the indices have come under intense pressure in recent years to increase their exposure to the sector, which has excelled. “ESG funds pay a higher expense ratio. If you start showing a negative tracking error because you don’t hold energy, you’re going to close down the fund at some point,” he said.

There are also calls for a better definition due to the ambiguity around what an equity portfolio with an ESG or sustainability focus should look like.

“I think that our industry is going through a time where the consumers of these products could benefit from additional clarification,” Parnassus Investments chief marketing officer Joe Sinha said about what investors expect to find in an ESG fund. The Parnassus Core Equity Fund, on the other hand, does not hold any oil and gas producers, which according to Sinha is equivalent to having oil reserves.

Rockefeller Asset Management's president and chief investment officer predicts that despite Big Oil's recent big market performance, more money will go into sustainable investing in the long run due to a "multi-decade, secular trend driven by increased evidence of risk and return benefits, an emerging generation of investors' preference for sustainability, and regulation that provides clarity and minimizes greenwashing."

While the company referred to 2020 and 2021 as "breakout years" for sustainable investing in its own ESG report, it refers to 2022 as "the blip" that was "turbulent" and marked by challenges for ESG investing as well as an energy crisis, which resulted in "mixed returns" for the strategy.