As more investors consider gaining exposure to Environmental, Social, and Corporate Governance (ESG) funds, recent performance is often an important consideration.
So, how did ESG focused equities perform in 2021?
Passive ESG funds
Generally, most passive global ESG funds/indices perform in line with expectations. They don’t take significant sector/regional deviations from their broad market benchmarks and small over/under performance each year is expected.
Indices such as the MSCI World Low Carbon Target and the MSCI World ESG Screened Index had little tracking error and performed similarly to the main global benchmark. Other ESG passive indices, such as the MSCI World ESG Leaders Index, outperformed the MSCI World by 3% over 2021.
Morningstar has shown that on average the main 13 ESG index funds that follow broad, diversified indexes of U.S. large-cap stocks outperformed the S&P index by c.0.5%.
Active ESG funds
While passive funds generally performed in line with expectations, active funds had a wide dispersion of returns, with many significantly underperforming the benchmark by -6% to -10%. However, generally, those funds that performed poorly in 2021 had a very strong 2020. It is important for investors not to chase returns.
Active funds take more risk and aim to achieve a higher return than the benchmark. When things go well, as in 2020, they can generate significant outperformance, but such strong performance is not sustainable.
Why did active ESG equities underperform?
Generally, ESG funds had expensive green stocks, which enjoyed significant gains in 2020, and no cheap non-green stocks, which fell in 2020. Undervalued stock went up and expensive stock went down. This can be clearly seen from the performance of concentrated ESG/Non-ESG fund/ETF.
The iShares MSCI Global Energy Producers ETF, which consists of big oil companies (Exxon, BP) was up 43% in 2021 (2020 -29%), while the iShares Global Clean Energy ETF, which consists of ESG favoured companies (Iberdrola, Orsted) was down -25% (2020 +140%).
What does 2022 look like for ESG focused equity funds?
Investors should not expect active funds to outperform every year. They should use 2021 as an example of why you should not chase returns – a disciplined investment approach is needed.
ESG funds can be significantly different and, for investors who do not want deviations from the broad market benchmark, passive ESG funds would be a better solution.
In 2022, passive ESG funds are more likely to perform in line with expectations due to taking less active risk. For those investors who are more tactical in their decision making, now could be a good time to consider these funds
If you would like to learn more about how your pension scheme might benefit from ESG funds, please speak to your investment consultant.