Updated: Apr 16, 2020
2020 has provided investors with a taste of how investments focused on SUSTAINABLE INVESTING perform during a market decline. From a peak on March 4th, the MSCI ACWI ETF (ticker: ACWI) representing 2,279 global stocks from 23 developing economies and 26 emerging markets, lost -28.4% en route to its recent bottom on March 23rd.
Investments that utilize an Environmental, Social, and Governance (ESG) approach to portfolio construction outperformed both their benchmarks and conventional investing peers. Based on the data I'll summarize below, we can attribute outperformance to that extra layer of ESG screening.
While we have data tracking the performance of ESG indices going back 3 decades, we don't have much in terms of empirical evidence. Many ESG funds, especially ETFs, don't have a track record that dates farther back than our last major bear market from the Great Recession in 2008. The information compiled below represents a first look at how actual ESG ETFs performed when challenged by the stock market.
ESG PERFORMANCE FOR US LARGE CAPS
The Morningstar Advisor Workstation database contains 10 US Large-Cap ESG themed ETFs receiving the highest SUSTAINABILITY RATING. The following table shows each fund's trailing 3-month total return performance data for the time period 1/14/2020 - 4/14/2020.
The average trailing 3-month total return for these funds is -12.02%. To put these numbers in context, investors can compare fund's results to both a "Category" as well as a "Benchmark". A category is simply a group of funds represented by a common investment style, i.e., U.S. large companies. A benchmark is comprised of actual stocks or bonds designed to represent an appropriate part of the stock or bond market.
3-Month Total Return for Morningstar US Large-Cap Blend Category: -14.76%
3-Month Total Return for Best-Fit Benchmark (Russell 1000): -13.64%
The average outperformance of U.S. large-cap ESG ETFs compared to the category (peers) is 2.74%.
The average outperformance of U.S. large-cap ESG ETFs compared to the benchmark (basket of representative stocks) is 1.62%.
ESG PERFORMANCE FOR INTERNATIONAL FUNDS
Using the same method for non-U.S. ESG ETFs, we come up with only 2 funds satisfying our criteria. To expand the sample size to generate more meaningful information, we can include emerging market ETFs as well as relax our sustainability rating to above average. This produces 14 results with trailing total return data for at least 3 months (1/14/2020 - 4/14/2020).
Average 3-Month Total Return of non-U.S. ESG ETFs: -17.69%
3-Month Total Return for Morningstar Foreign Large Blend Category: -19.23%
3-Month Total Return for Best-Fit Benchmark (MSCI ACWI Ex-US): -19.45%
The average outperformance of foreign ESG ETFs compared to the category (peers) is 1.54%.
The average outperformance of foreign ESG ETFs compared to the benchmark (basket of representative stocks) is 1.76%.
ESG PERFORMANCE FOR BONDS
While there are 9 ESG bond ETFs in existence today, only 2 are designed to represent the entirety of the U.S. bond market. The other 7 have narrow focuses such as green bonds, corporate ESG bonds, or high yield ESG bonds. It wouldn't be appropriate to lump the 7 highly focused ESG bond ETFs in with this analysis since their benchmarks are all different. Based on our two players, here's what we have for the time period 1/14/2020 - 4/14/2020.
Average 3-Month Total Return of Bond ESG ETFs: 4.46%
3-Month Total Return for Morningstar Intermediate Core Bond Category: 2.39%
3-Month Total Return for Best-Fit Benchmark (Bloomberg Barclays Aggregate Bond Index): 3.78%
The average outperformance of bond ESG ETFs compared to the category (peers) is 2.07%.
The average outperformance of bond ESG ETFs compared to the benchmark (basket of representative stocks) is 0.68%.
THE BIG PICTURE
First, a word of caution. As much as I'd love to claim ESG funds outperformance during bear markets as dogma, we just don't have enough real-life data to say this yet. There are different ways to approach the ESG performance conversation, each with its own set of advantages and disadvantages. This short blog post isn't the end of the conversation. It represents the beginning.
I chose to include only ETFs in my analysis. I did this for several reasons. First, that's primarily the investment vehicle of choice at Aspen Leaf Wealth Management. Second, ETFs by nature are usually designed as index funds, meaning they are passively managed and track an underlying benchmark (allowing for apples to apples comparisons). Third, using ESG mutual funds complicates the analysis since these funds tend to be actively managed (attempting to outguess the market). Using actively managed ESG mutual funds would've added a 2nd variable that skewed the results. For example, was the performance due to material ESG factors or was the portfolio manager simply lucky (or unlucky)?
While ESG indices have outperformed in the past, this isn't always the case*. For example, in 2008, the KLD 400 Social Index produced a total return of -35.93% while the S&P 500 returned -37.00%. Advantage, ESG investing. But, from 2000 through 2002, the KLD 400 Social Index produced an average annual return of -14.98% while the S&P 500 returned -14.36%. Advantage, conventional investing.
Sometimes sustainable investing with its ESG layer of screening outperforms. Sometimes it doesn't. The important thing to remember is that sustainable investing is competitive with conventional investing.
In fact, Wall Street titan Morgan Stanley analyzed over 10,000 funds using the same Morningstar data set I use. Their 2018 research produced two myth-busting conclusions. First, sustainable investing doesn't actually underperform as was previously assumed. Second, sustainable investing experienced 20% less downside deviation (the bad kind investors loathe when markets decline), which they concluded was a statistically significant finding.
You can read the full report HERE.
If you're a sustainably-minded investor already utilizing an ESG screening approach with ETFs, be happy you're doing better so far in 2020 than the average investor as well as the benchmark.
If you've heard about ESG and are sustainable-curious, be sure to check out our ESG GUIDE. Sustainable investing is all we do at Aspen Leaf Wealth Management. An overview of our various portfolio options can be found HERE.
When you're ready to initiate a no strings attached discussion about improving your portfolio for yourself, people, and the planet, reach out by clicking the "Contact" link in the upper right corner of this page.
* Source: Morningstar Advisor Workstation