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Value veteran Jeremy Grantham is fond of saying managers have exactly 3.0 years to prove themselves to consultants, professional fund buyers, and pension funds.
If this maxim holds true, large-cap ESG managers have just under two years to turn around a run of performance starting in January 2021, and remain in good standing with professional investors.
The beginning of 2021 is significant because ESG funds are notoriously light on energy, a sector of the S&P 500 that has returned more than 80% on an annualized basis since that time, when Covid-19 vaccines appeared and the world began to emerge from lockdowns.
The S&P 500 currently has a 4% weighting to energy stocks while the average large-cap fund in Morningstar’s ESG universe had 1.7% of its portfolio in the sector.
While energy is not a big part of the S&P, large-cap ESG managers’ average underweight to the sector has hurt performance. Of the 105 such funds with a track record going back to start of March 2021, the average strategy has delivered a 13.54% annualized return over that period, lagging the S&P’s 17.91% by more than four percentage points. One fifth of the funds produced an annualized return of 10% or less, nearly eight percentage points behind the index.
Meanwhile, just 17 of the 105 funds beat the S&P 500 index’s 17.91% annualized return from the start of 2021 through March of 2022.
This group did not include the biggest large-cap ESG funds, the $29.5bn Parnassus Core Equity fund (PRBLX) and the $24.5bn iShares ESG Aware MSCI USA ETF (ESGU), which delivered 15.94% and 15.25% annualized returns, respectively, over the period.
These funds – which finished 35th and 43rd out of the 105, respectively – have combined assets of $54bn, which accounts for nearly 30% of the $181bn in assets in all large-cap ESG funds.
The third largest fund, the $15.9bn Vanguard FTSE Social Index fund (VFTNX) accounts for another 8.8% of the category’s assets. It has no energy exposure and finished the 15-month period with a 14.38% annualized return, trailing the S&P 500 by more than three percentage points.
The large-cap ESG funds that did outperform the S&P over this period, unsurprisingly, tended to have higher energy exposure than those that lagged. The 10 best performers, on average, had a 4% allocation to energy, in line with the index, although some had much less than this and still posted impressive numbers.
Top large-cap ESG funds since the start of 2021
Fund | Annualized return, 2021-01-01 to 2022-03-31 | Energy exposure | Fund Size ($m) |
---|---|---|---|
Columbia Sustainable US Equity Inc ETF (ESGS) | 26.47 | 9.49 | 27.30 |
Baywood Socially Responsible Instl (BVSIX) | 22.86 | 7.14 | 7.10 |
Xtrackers S&P 500 ESG ETF (SNPE) | 20.78 | 4.35 | 894.10 |
Gotham ESG Large Value Institutional (GESGX) | 20.76 | 6.01 | 1.50 |
SPDR® S&P 500® ESG ETF (EFIV) | 20.71 | 4.34 | 499.00 |
AVDR US LargeCap ESG ETF (AVDG) | 19.29 | 5.49 | 2.40 |
Xtrackers MSCI USA ESG Leaders Eq ETF (USSG) | 18.75 | 1.68 | 3,195.00 |
iShares ESG MSCI USA Leaders ETF (SUSL) | 18.72 | 1.69 | 3,637.00 |
Fidelity® U.S. Sustainability Index (FITLX) | 18.70 | 1.54 | 2,523.00 |
PIMCO RAFI ESG US ETF (RAFE) | 18.69 | 0.00 | 30.10 |
Source: Morningstar Direct / Data through March 31
The best large-cap ESG fund over the 15 months was the $27m Columbia Sustainable US Equity Income ETF (ESGS) with a 26.47% annualized return. The fund has more than 9% of its assets in energy stocks, including pipeline firm Kinder Morgan Inc Class P.
An entrant from Joel Greenblatt’s Gotham Asset Management, the tiny $1.5m Gotham ESG Large Value fund (GESGX), finished fourth with a 20.76% return. The highly diversified, 234-stock fund has 6% of its assets in energy, including 1.7% in ExxonMobil, its third-largest holding.
The 1oth best fund, the $30m Pimco RAFI ESG US ETF (RAFE) managed to notch an 18.69% annualized return for the period, despite the fact that it currently has no energy stocks. The fund, subadvised by Rob Arnott’s Research Affiliates, accomplished the trick with 25% technology exposure, and its top holdings in that sector are a mixture of hardware names like Intel and Cisco, and software or platform names like Microsoft and Apple.
Large-cap ESG funds enjoyed a stellar 2020 – 60 of the then 88 funds beat the S&P’s 18.4% return, largely thanks to technology overweights and energy underweights – and investor appetite remains high for the wider style of investing, with a record $69.2bn pouring into ESG funds and ETFs in 2021.
All of which might mean large-cap ESG funds are an exception to Grantham’s rule. Whether a continued energy rally tests investor patience remains to be seen.
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