Green investing is underperforming, but don’t count it out just yet
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Investors for the last two years poured money into environmental, social and corporate governance investment strategies.
In 2020, net new assets into ESG funds jumped to $51.1 billion — more than double the year before. And last year, these funds attracted nearly $70 billion in new assets, according to data from Morningstar.
Indeed, investors are increasingly considering more than financial returns when allocating their investment dollars. But at times, investing responsibly comes at a cost. And many ESG investors are seeing their portfolio values decline significantly this year, both on an absolute and relative basis.
The question is: If ESG funds continue to struggle, how patient will investors be?
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Of course, it’s not unusual for investors to grow impatient during periods of sustained underperformance. Although net flows into ESG-designated funds remain positive so far this year, according to data from YCharts, many ESG funds are already experiencing outflows year to date. Fortunately, long-term investors who don’t want to sacrifice their values for performance have many reasons to be optimistic about the future of sustainable investing.
Funds that incorporate ESG into their investment decisions are off to a bumpy start this year. Then again, so is the broad U.S. stock market; the S&P 500 Index, a popular proxy for U.S. stocks, is down more than 10% since the start of 2022, placing the index firmly in correction territory.
It seems there are few places to hide in the current market environment. And sustainable funds — particularly those that consider environmental issues — are having even more trouble keeping up with their non-ESG counterparts.
So, what’s driving ESG underperformance this year?
Few areas of the market are doing well year to date. However, one bright spot has been the energy sector. Oil prices have spiked to record highs recently because of ongoing supply chain issues and recent geopolitical events. Thus, the S&P 500 Energy Sector is up over 28% year to date on a price-return basis.
At the same time, big tech names have sold off sharply as investors, of course, anticipated that the Federal Reserve would raise interest rates in the near term. The S&P 500 Information Technology Sector is down more than 16% this year as a result.
This drastic divergence in sector performance is largely responsible for the recent underperformance of ESG funds. Many ESG funds avoid the carbon-intensive energy sector and instead overweight technology names. While these relative positions paid off in 2020 and 2021, they’re proving to be headwinds so far this year.
All investment strategies face headwinds from time to time. Yet that doesn’t always mean investors should jump ship when times are tough. When stock prices fall, it’s often helpful to take a longer-term view and focus on the opportunities that lie ahead.
And long-term ESG investors have many reasons to be optimistic about the future. Here are just a few examples of how ESG investors may be rewarded in 2022 and beyond.
As climate change becomes a larger focus, pressure is mounting on big corporations to do their part to combat global warming. Many of the world’s largest companies are working towards net zero carbon emissions — and pressuring others to follow their lead. For example, Amazon and IKEA are among the major companies pushing the ocean shipping industry to adopt zero-carbon fuel sources for vessels by 2040.
The sustainable debt market reached new levels in 2021, exceeding $1.6 trillion in new issuance, according to data from BloombergNEF. This rapidly growing market may prove instrumental in helping companies unlock financing to meet their ESG goals.
It may also help further ongoing diversity and inclusion efforts in communities. For example, social bonds, which finance social and community-based projects in full or jointly with green objectives, played a key role in bolstering communities during the Covid-19 pandemic. (This type of borrowing is typically earmarked for more vulnerable and underserved populations.)
Investors continue to push for more transparency from companies on how they’re managing risks related to climate change. In response, Securities and Exchange Commission Chair Gary Gensler announced last year that the agency would use its authority to require climate-related disclosures. Moreover, asset managers are pushing companies for more disclosure on climate change, deforestation and water security in order to make better investment decisions.
In fact, the SEC plans to propose new rules for publicly traded companies this month. These rules would require companies to report standardized information about their emissions as well as the climate-related risks they face near- and long-term. Better information would help investors avoid companies most likely to be affected by climate change and support companies most committed to combatting it.
Long-term investors have many reasons to stay the course. Climate change is driving new corporate policies and is a key component of the Biden administration’s agenda (as well as that of many governments worldwide). In addition, the Covid-19 pandemic and Black Lives Matter movement has helped shine a light on social inequity and injustice. As a result, socially and environmentally conscious investors are likely to continue to demand more from the companies in which they invest.
Ultimately, all investing requires patience. ESG investors are experiencing that now — some, perhaps, for the first time. Fortunately, market trends tend to be cyclical. But the fundamental trends driving sustainable investing are more likely to endure.
— By Cathy Curtis, certified financial planner and founder and CEO of Curtis Financial Planning