Image: Markus Winkler via Unsplash.
Oil and gas stocks jumped last year. Although this threatened to lure investors away from ESG-linked choices, half of the largest sustainable investment exchange-traded funds did better than the S&P 500.
As with many other funds, stock selection, rather than sector preference, was the main reason for the surge, according to Market Watch.
Many ESG ETFs held some of the same technology companies and recognizable brands which helped drive gains in their broader indexes, such as Nvidia or Tesla. Furthermore, weightings also mattered, and some were overweight on a few critical names, giving them a further boost relative to the S&P 500’s performance.
Last year, the technology sector soared by around 35%, while the S&P 500 had a total return of 28.7%. Many investors worried that the broad-based ESG ETFs would be missing out amid the energy sector’s rally. Yet despite growth on robust fuels demand, petroleum producers remain only a small portion of the broader market.
Several of the largest ESG ETFs are sector-neutral funds designed to have similar exposure to broader markets. These could emerge as substitutes for traditional core holdings. Thus, energy companies can be added to ESG ETFs if they have high social or corporate governance scores. And many energy companies are, themselves, in transition to lower emissions businesses.
Sustainable portfolios can provide better long-term risk-adjusted returns as the economy continues to transition towards carbon neutrality. That may allow investors to pursue their investment objectives and sustainability goals at the same time.
Analysts claim that stock selection was why some ESG ETFs perform strongly. The top holdings in iShares and Vanguard ETFs are weighted similarly to the assets in the S&P 500. The Nuveen and Xtrackers ETFs were overweight on Tesla and Nvidia.
The performance was no doubt welcomed by investors. It does, however, raise some important questions. Many major renewable energy plays such as wind turbine manufacturers or greener utilities saw prices decline last year amid supply chain problems and high commodities prices. Investors may also want to review all of an ETF’s holdings. As investors usually buy ESG ETFs for “do good” reasons, there may be real benefits to the companies they include or exclude.
These ESG ETFs can be considered as passive index funds that follow predetermined rebalancing rules. Because of this, the heavier weights of certain highfliers aren’t necessarily a sign of goosing returns – companies in ESG index ETFs are generally selected as they score high from an ESG perspective, not on valuation or momentum characteristics.
That funds incorporating ESG criteria kept pace during a very positive market run is a good sign. The next test will be to see how they do amid tougher headwinds.
