The S&P’s energy sector surged more than 50% last year – so how were green funds able to keep up with the stock market?

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Fossil-fuel energy stocks return in 2021. That could have spelled doom for the performance of sustainable investment exchange-traded funds — but nearly half of the largest ESG offerings outperformed the S&P 500.

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But like many funds, stock selection, rather than sector bias, is the main reason, said Todd Rosenbluth, director of ETF research at CFRA.

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Many ESG ETFs contained some of the biggest technical names, which also helped power broader indexes such as the Apple AAPL.
+0.51%,
Amazon AMZN,
+0.57%,
Tesla TSLA,
+1.75%,
nvidia nvda,
+1.38%
and Microsoft MSFT,
+1.77%,
Weight matters too; Some were overweight some of the major names versus the broader index SPX,
+0.08%,

The technology sector climbed about 35% in 2021, and is the largest sector in the S&P 500 at 29%. Energy, meanwhile, is one of the smallest S&P 500 sectors at 2.7%, which has dampened the impact of its 53% surge. Last year the S&P 500 had a total return of 28.7%.

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Rosenbluth said there was a belief that broad-based ESG ETFs would be missing amid the energy sector rally. He knew this was wrong. “Because energy is such a small slice of the broader market, it was not going to be detrimental to their performance.”

Many of the largest ESG ETFs are sector-neutral funds, designed to have exposures similar to the broad market exposures they track and can be alternatives to traditional core holdings. Energy companies can sometimes be included in an ESG ETF if they have high social or corporate governance scores.

Having names of energies doesn’t always lead to better performance. The best example of this is iShares ESG Aware MSCI USA ETF ESGU,
-0.09%,
The largest ESG ETF by assets under management at $25.7 billion, the energy sector has a 2.9% weighting, slightly higher than the S&P 500. It rose 26.7%, trailing the S&P’s gains.

“They may not own some of the better performing energy companies that have performed poorly from an ESG perspective,” he said.

Lucas Smart, Head of US iShares Sustainable and Factor Strategies at BlackRock BLK,
-2.19%,
Said Asset Manager believes that sustainable portfolios “could provide investors with better long-term risk-adjusted returns as society navigates the transition to a low-carbon economy.”

He added that BlackRock’s suite of ESG ETFs “give all investors more choices in how they meet their investment objectives and sustainability goals.”

While the iShares ETF was slightly behind the broader market, the others among BlackRock’s ESG funds outperformed the S&P. These include the $4.39 billion iShares MSCI USA ESG Select ETF SUSA,
-0.20%,
which has 1.35% energy load; $4 billion iShares ESG MSCI USA Leaders ETF SUSL,
+0.15%,
with 1.16% energy load; and the $4 billion iShares MSCI KLD 400 Social ETF DSI,
+0.01%,
With 0.94% energy load. All three returned at least 30%.

Among other broad-based ESG ETFs weighing less than Energy, the Xtrakers MSCI USA ESG Leaders Equity ETF USSG,
+0.12%,
Of the $3.8 billion fund, only 1.2% is energy exposure, up 31.8% to end 2021.

Vanguard ESG US Stock ETF ESGV,
-0.06%,
The second largest ESG ETF by AUM is $4 billion, with only 0.25% invested in the energy sector. It rose 26.6% in 2021, slightly behind the S&P, but closely tracking its benchmark, the FTSE US All Cap Choice Index, which includes 1,500 securities.

Change Finance US Large Cap Fossil Fuel Free ETF CHGX,
-0.30%,
$117.5 million fund whose sole energy exposure comes from solar panel manufacturer Sunrun RUN,
-2.90%,
rose 28.4%. Nuven ESG Large-Cap Growth ETF NULG,
+0.02%,
A $913 million fund that has only 0.4% energy grew 28.2%.

“It highlights how you could still do well with a fossil-fuel-free approach, simply because the energy is so small,” Rosenbluth said.

How broad-based ESG ETFs stack up in 2021

Name

anchor

2021 Returns

AUM, billions of $. In

iShares ESG Aware MSCI USA

ESGU

26.70%

$25.70

Vanguard ESG US Stock ETF

ESGV

26.60%

6.4

iShares MSCI USA Select ESG ETF

sousa

30.50%

4.8

iShares ESG MSCI USA Leaders ETF

Sushil

31.50%

4.3

iShares MSCI KLD 400 Social ETF

dsi

31.30%

4.2

Xtrakers MSCI USA ESG Leaders Equity ETF

USSG

31.80%

3.8

Extractors S&P 500 ESG ETF

SNPE

31.40%

0.9

Nuven ESG Large-Cap Growth ETF

FIR

28.20%

0.9

iShares ESG Advanced MSCI USA ETF

USXF

27.10%

0.6

IQ Candream ESG US Equity ETF

IQSU

30.50%

0.5

SPDR S&P 500 ESF ETF

EFIC

31.30%

0.5

Change Finance US Large Cap Fossil Fuel Free ETF

chgx

28.40%

0.1

S&P 500

Spy

28.70%

Sources: CFRA Research, Marketwatch

stock selection

Rosenbluth says some ESG ETFs outperform because of stock selection. While the top holdings in the iShares and Vanguard ETFs are weighted similarly to the holdings in the S&P, the Nuveen and Xtrackers ETFs were more heavily weighted than Microsoft, Tesla and Nvidia, but had no exposure to Amazon and Apple. Change Finance weighed less than top technology names, suggesting that other stock holdings affected the performance.

Fund

Exposure to mega-cap stocks (% of assets)*

Apple

Microsoft

heroine

Tesla

NVIDIA

iShares ESG Aware MSCI USA

6.6

5.6

3.5

2.2

1.8

Vanguard ESG US Stock ETF

6.8

6.1

3.6

2.1

1.7

Xtrakers MSCI USA ESG Leaders Equity ETF

10.7

4.24

3.3

Nuven ESG Large-Cap Growth ETF

11.5

3.9

3.8

Change Finance US Large Cap Fossil Fuel Free ETF

1.04

0.95

0.85

iShares MSCI USA Select ESG ETF

5.6

4.59

2.1

2.5

iShares ESG MSCI USA Leaders ETF

10.4

4.2

3.2

iShares MSCI KLD 400 Social ETF

9.9

4

3

S&P 500

6.8

5.9

3.6

2.2

1.7

*Up to 13 January 2022

He said this is a reminder for investors to not only look at a fund’s 10 largest holdings, but to review all of an ETF’s holdings. People usually buy ESG ETFs for “do well” reasons, but it may be that the companies that they include or exclude have fundamental advantages.

“We oppose all stocks that are included and excluded from ESG ETFs, not just those in the top-10 positions, matter more than the fund’s expense ratio or its assets under management, although we think that many people like that. ETFs are selected on the basis of metrics,” he said.

All these ESG ETFs are passive index funds that follow preset rebalancing rules, he added. This means that for some high fliers, heavier weights are not indicative of increased returns. Companies in ESG Index ETFs are generally chosen because they score high from an ESG perspective, not on valuation or momentum characteristics.

“They were lucky to have stocks that they weighted favorably, or there were some high-flying stocks that were overweight,” he said.

Debbie Carlson is a Businesshala columnist. follow him on twitter @DebbieCarlson1,

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