How Did Large-Cap Sustainable Stock Funds Perform in Q3?
Stock-pickers led the way, particularly high-conviction funds.
Over a half of the sustainability large-cap stock funds and exchange-traded funds beat the Morningstar US Large-Mid Cap Index in the third quarter, a larger percentage than the 33% of conventional large-cap funds that beat the index, according to data provided by Morningstar Direct. High-conviction funds produced some of the strongest returns.
Some 61 of 118 diversified large-cap sustainable equity funds and ETFs--or funds that identify themselves, by prospectus, as following environmental, social, and governance strategies--outperformed the Morningstar US Large-Mid Cap Index. By contrast, 485 of the 1,477 funds and ETFs in the overall large-cap growth, large-cap value, and large-cap blend Morningstar Categories combined beat the index. For people searching for evidence that sustainable investing outperforms, the results were mixed. As a group, large-cap sustainable funds lagged the index, returning 0.06% for the quarter versus 0.29% for the large-mid cap benchmark.
If there was any doubt that ESG is an active strategy, the third quarter’s strongest returns came from concentrated funds, where most of the assets reside in the manager's highest-conviction ideas. It was dominated by dedicated stock-pickers like Quoc Tran, a Bay Area investor who looks for companies with high returns on equity. Tran’s fund, with just $64 million in assets, owns 25 names and appears on our list as number three, Lateef Focused Sustainable Growth (LIMIX), which has been renamed Tran Capital Focused. “We lost the word ‘sustainable’ because the title was too long,” Tran says. Too small for a full Morningstar analysis, the fund practices sustainable investing by prospectus. Big gainers in the fund include two companies pushing enterprises to transform digitally, including cybersecurity outfit Palo Alto Networks (PANW), up 29% during the quarter as demand for enterprise security software accelerates, and customer relationship management titan Salesforce.com (CRM), up 11%. “Both have a culture of being very intentional about how they treat employees, customers, and communities in which they operate,” Tran said in an interview.
Quoc Tran’s fund became a sustainable fund four years ago, just after Tran bought his former employer, Lateef Investment Management. Tran relates that he attended conferences about impact and sustainable investing after he bought the firm, a time when wildfire seasons in California were growing progressively more destructive. He also saw the discipline as a way to “eliminate long-tail risk.” Last year, for example, he decided to sell Facebook (FB). “We didn’t think they took the impact of their businesses seriously and had concerns [the CEO] didn’t have checks on his power,” Tran said.
Over the three-year period, the fund was in the 41st percentile for returns. For the year, it has a solid top ranking. Tran is optimistic that his sustainable stocks will continue to outperform: “We think we can grow for longer than the consensus believes,” he says.
Number one on the list is Brown Advisory Sustainable Growth (BAFWX), run by Karina Funk and David Powell. It earns a Morningstar Analyst Rating of Silver and is up 5% for the quarter. Funk and Powell look for firms benefiting from secular drivers and sustainable business advantages that are managing ESG risks well. There aren’t many, apparently: That’s why the fund owns just 35 or so stocks. Microsoft (MSFT), its largest position, Alphabet (GOOGL), and Danaher (DHR) account for nearly 14% of assets.
In an interview, Funk said that the fund’s “really conscientious overweight” in healthcare was one performance driver in the third quarter. For health, “it’s clear COVID-19 had an overwhelmingly positive impact” on the fund’s bets on life sciences and diagnostic plays, including Thermo Fisher Scientific (TMO), up 13.3% during the quarter, Danaher, up 13.5%, and West Pharmaceutical Services (WST), up 18.3%. “Anybody could legitimately question whether growth rates would be compromised as testing wanes” and vaccination rates stabilize, Funk continued. “But we have a multiyear investing approach. The companies have a lot of dry powder now for capital allocation and have been able to raise their long-term core growth rates.”
Number two, Aberdeen U.S. Sustainable Leaders (GXXAX), jumped up 3.9% for the quarter. The fund looks for companies that it deems to have improving prospects and that are current or emerging leaders in managing ESG risks and finding ESG opportunities. It has just 33 holdings. The largest three--Microsoft, engineering outfit Tetra Tech (TTEK), and Israeli software outfit Nice (NICE)--account for 18.2% of assets.
Number four was Bronze-rated Calvert Equity (CSIEX), up 3.1%. The fund is subadvised by managers led by Joseph Hudepohl of Atlanta Capital, a unit of Morgan Stanley. The fund owns 61 stocks. Its two largest positions are Thermo Fisher and Danaher.
Data journalist Katherine Lynch contributed to this article.
Leslie Norton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.