Although environmental, social, and governance (ESG) factors have been garnering healthy inflows over the past year, the path to performance will be uneven and a long-term view is requisite, according to Morningstar’s ESG Risk/Return Analysis.
The research and data analytics firm found that 34% of the firm’s ESG indexes, which include equities and bonds in various regions, outpaced their non-ESG equivalents in January.
That’s lower than 2021’s outperformance rate of 57% and 2020’s 75%.
The report attributed the drop mainly to divergences in sector returns.
For example, many ESG funds carry heavier weights in tech stocks than the broader market, and largely avoid the carbon-intensive energy sector.
In general, tech stocks have sold off sharply as investors are increasingly more cautious about growth trades and their high price tags in a rising rate environment.
By contrast, energy stocks have had a bumper year so far on the back of rising commodity prices thanks to supply chain constraints and geopolitical risks.
However, the Morningstar report showed that adopting a longer-term horizon typically generates better outcomes.
It revealed that over the five-year period ended December 31, 2021, 88 of the 110 of Morningstar indexes with a five-year history beat their non-ESG equivalent while 97 of the 110 lost less than their non-ESG equivalent during down markets.
In calendar year 2021, 66% of Morningstar’s 116 ESG indexes did better their non-ESG equivalents, down from 75% in 2020, partly attributable to the strong showing of the carbon-intensive global energy sector.
“Contrary to conventional wisdom, investing based on environmental, social and governance criteria does not necessarily mean sacrificing return,” says Dan Lefkovitz, strategist, Morningstar Indexes. “Nor is it a guaranteed route to market-beating performance.
What is certain is that any deviation from a market portfolio will result in a different outcome and studying past ESG behaviour through indexes can help guide sustainability-focused investors going forward. Sustainable investors should be encouraged to see that ESG indexes have posted competitive returns with lower risk over the long term.”
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