Sustainable investing generated returns similar to those of the overall market in 2022. The broad Morningstar US Sustainability Index fell 18.9% in 2022, outperforming the 19.5% decline of its parent, the Morningstar US Large-Mid Cap Index. Over the same time, the S&P 500 fell 19.4%.
As with markets generally, value stocks outperformed growth by a large margin among environmental, social, and governance investments. “These market dynamics were unfavorable for sustainable investments,” says Dan Lefkovitz, strategist for Morningstar Indexes. Consider that the Morningstar US Sustainability Large Cap Broad Growth Index lost 30.1% over the year, nearly 3 times the 10.1% decline of its Morningstar US Sustainability Large Cap Broad Value counterpart. Energy, a traditional value sector, was by far the best-performing equity sector, while the growth-leaning technology sector was one of the worst.
To be sure, index performance relied heavily on the underlying components. For example, the Morningstar US Sustainability Index outperformed its parent because it didn’t include Amazon.com AMZN or Tesla TSLA, which both performed horribly during the year.
But the more focused Morningstar US Sustainability Leaders Index fell 24.5% in 2022, lagging the 20.4% fall of its parent, the Morningstar US Large Cap Index, because of its growth bias and heavier exposure to stocks like Nvidia NVDA, Salesforce CRM, and Adobe ADBE, Lefkovitz says.
Other sustainability-themed indexes lagged, owing to the growth bias. The Morningstar Minority Empowerment Index underperformed the broad market.
Climate Indexes Lag
When it came to climate indexes, the Morningstar Global Markets EU Climate Transition Benchmark and the Morningstar Global Markets Paris Aligned Benchmark both underperformed the broad global equities market. “Again, being underweight energy and overweight technology accounts for a significant amount of the underperformance,” Lefkovitz says.
Some Sustainable Indexes Outperformed
Not all sustainable indexes were laggards, a reminder that sustainable investing is a big category with many different strategies available to investors. For example, the Morningstar Women’s Empowerment Index fell 17.2%, beating the broader U.S. market. The index is overweight energy and underweight technology, owing to gender diversity within those sectors. “This speaks to the fact that sustainable investing is a diverse field that can take many forms,” Lefkovitz says.
And of course, sustainable indexes with a value bias were market beaters. The Morningstar US Sustainability Dividend Yield Focus Index fell just 2.3%.
Some ESG Funds Outperformed, Too
The top large-cap fund with an ESG bent was tiny Baywood Socially Responsible BVSIX, which fell 0.72% in 2022. The fund has a Morningstar Analyst Rating of Neutral. The strategy was founded in 2000, a time that technology valuations were sky-high, as they were in early 2022. Back then, valuations reflected revenue far in the future owing to Y2K. This time, the valuations reflected expectations sparked by the pandemic.
The fund avoids companies with high ESG risk, as well as overvalued companies. It sidestepped some of the worst performers “by focusing on governance, which we believe is a leading indicator of how companies act on social and environmental matters,” says Matthew Segura, director of institutional portfolio management at SKBA Capital Management, a San Francisco value boutique that advises the fund. “IT and communications companies seem to get a free pass on ESG. Very few pay attention to poor records on supply chains, social matters.” The fund also looks for companies with improving ESG profiles, in addition to traditional metrics that show a company is unloved versus its peers, such as yield and market cap/revenue.
Baywood also benefited from the boom in energy. One big performer was Atlas ATCO, whose containership and mobile gas turbine fleets benefited from soaring energy prices. In August, Atlas agreed to be acquired by Poseidon, an investment vehicle. Another winner was Texas Pacific Land TPL, which owns 880,000 acres in the Permian Basin, which is rich in energy, sun, and wind. A third is fertilizer company Nutrien NTR, which nearly doubled in the early days of 2022 before Russia invaded Ukraine.
Among large-cap funds with high Morningstar Sustainability Ratings but without a sustainable focus, City National Rochdale Equity Income RIMHX fell just 0.24%. The City National fund’s largest sector exposures are financials, utilities, and consumer staples, and its largest holdings are Marathon Petroleum MPC, Chevron CVX, and regional bank First Horizon FHN.
What’s next? “We believe we’re at a very long unwinding of the asset bubble created by the Fed’s 10 years of a zero-rate policy,” says Segura of Baywood. “Rationality is only beginning to be restored to investment decision-making.” That will create investment opportunities in the coming year.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.