Only two sectors — energy and utilities — have performed well this year, and that has led a handful of sustainable funds with substantial exposure to them to see positive returns.
That trend has also put most sustainable funds at a massive disadvantage, at least in the short term.
As of the end of July, only nine US open-ended mutual funds and ETFs had experienced positive total returns, according to data provided to Portfolio Adviser sister title ESG Clarity by Morningstar Direct. A common theme among those products: ties to the energy sector.
Those returns ranged from less than 1% to nearly 31%, well ahead of the median of -13.9% among all US funds Morningstar categorises as sustainable.
The sustainable funds leading the pack on year-to-date returns “are getting the side effects of the energy rally,” says Alyssa Stankiewicz, associate director of sustainability research in Morningstar’s manager research. Mostly, the products with more than a 0% return fall into the clean energy category, Stankiewicz says.
Top 10 US sustainable funds for total return
| Fund | YTD return as of 29 July (%) |
| Victory Global Energy Transition | 31 |
| Invesco Solar ETF | 10.5 |
| AQR Sustainable Long-Short Equity Carbon Aware | 9.7 |
| First Trust EIP Carbon Impact ETF | 7.4 |
| iShares Global Clean Energy ETF | 6 |
| Global X Solar ETF | 6 |
| SPDR Kensho Clean Power ETF | 2.8 |
| Kayne Anderson Renewable Infrastructure | 1.4 |
| Virtus Duff & Phelps Clean Energy ETF | 0.8 |
| CrossingBridge Responsible Credit | -0.2 |
Source: Morningstar Direct
An environment with extraordinarily high gas prices and record profits for oil companies has put funds without holdings in them at relative disadvantage compared to peers, as most sectors are struggling in the current economy.
As of 3 August, the S&P 500 Energy Index was up 37% year to date, while its Utilities Index was up 5.5%, according to Morningstar Direct data. By comparison, the total return for the S&P 500 was -12.1%, and the Communication Services Index was at -26.2%.
“It’s not just sustainable funds that are struggling this year,” Stankiewicz says.
However, 32% of funds in Morningstar’s sustainable category ranked in the bottom quartile among peers for performance, she notes.
“It does appear that sustainable funds are faring worse,” due in part to high allocations to communications and tech, she says.
Some 14% of sustainable funds were in the top quartile among peers for total returns, while 27% were in the second quartile and another 26% in the third.
Although each of the nine funds with positive total returns year-to-date was an equity product, fixed income funds led the list of the funds with the smallest negative returns. Most of the funds with negative returns higher than 10% were equity or allocation products.
Fund shareholders have responded to the dip in performance by pulling assets from products. US sustainable funds experienced net outflows of $1.6bn (£1.3bn) during the second quarter, representing the first quarter with net redemptions in more than five years. Outflows were fueled by active equity fund shareholders, as net sales for sustainable bond funds were positive.
Among all US funds – sustainable or otherwise – net outflows for the second quarter stood at $150bn (£126bn).
Time in the sun
Two of the top-performing funds are ETFs that invest primarily in the solar-energy business, which has seen significant volatility.
“Leading up to 2020, this was still an area of the market that didn’t really recover from the global financial crisis,” says Rene Reyna, head of thematic and specialty product strategy for Invesco.
The $2.3bn Invesco Solar ETF, which launched in 2008, was up 220% in 2020, as investors took note of a decline in solar and the incoming Biden administration, Reyna says.
“The share prices were getting well ahead of fundamentals. We started to see reversals post-election,” he says. The ETF saw a 10-year high in January 2021, though it fell 40% by January 2022.
Through July, that ETF was up 10.5% year-to-date, according to the date from Morningstar Direct. The share price hit a low point for the year in May and has since been trending upward.
“There wasn’t a lot of acceleration yet in some of the proposals for the climate plan. And quite frankly, it was overbought when you look at the share price. We’ve been through some volatility since then,” Reyna says.
The fund, which has holdings across the solar energy value chain, has benefitted from more demand for solar amid high fossil-fuel energy costs, even with inflation and persisting supply chain issues.
On Friday, Congress gave final approval to the US climate bill, the Inflation Reduction Act, which includes about $370bn in investments for energy security and climate change.
“It’s going to be the single biggest climate investment in US history,” Reyna says, describing the legislation as “icing on the cake” for solar.
Other performance leaders
By total returns, the top performing US fund so far this year in Morningstar’s sustainable universe is the Victory Global Energy Transition fund, which invests primarily “in companies operating in natural resources industries that will be required for the energy transition,” the firm states on its site. That fund invests heavily in mining and fossil fuel companies.
Another fund with top returns is the AQR Sustainable Long/Short Equity Carbon Aware fund.
Launched in December 2021, it is the first sustainable long/short US mutual fund on the market, according to the firm. The fund can short companies that don’t do well on ESG measures, although it seeks to be net zero overall, with the carbon footprints of those short positions added to those of the more sustainable securities it holds long.
The fund’s leading driver of outperformance this year was valuation, as cheap stocks have seen strong returns, the company says. However, the fund has also seen stronger returns from stocks with good performance on ESG metrics.
Meanwhile, its short positions on fossil-fuel companies detracted from returns.
Biggest fund
That fund, like other sustainable ones, avoids fossil-fuel investments, Parnassus CEO Ben Allen says.
The largest sustainable US mutual fund on the market, the $27bn Parnassus Core Equity Fund, saw total returns of -13.9% year-to-date as of the end of July, Morningstar Direct data show.
“By far, the biggest thing to note is sustainable strategies that avoid investing in fossil-fuel companies have had headwinds relative to their benchmarks this year,” Allen says.
It’s unusual to see the energy sector rallying when the wider stock market is down significantly and there are fears of a recession, he notes. “If you’re positioning your portfolio to have some downside protection features for a recession, generally being underweighted in energy companies would help you.”
Because the fund is clear about its policy on oil and gas, shareholders have been understanding, although there have been outflows as investors have adjusted their portfolios, he says.
“This is one of the benefits about being clear on our approach to sustainable investing relative to fossil fuels,” Allen says.
“In the past few years, it has helped us, when oil went down to negative territory … We still think that it’s the right thing to do from a performance standpoint over the long term. Oil prices aren’t going to go up forever — they will go down sometime.”
This article first appeared on our sister publication ESG Clarity
