Staying On Track With ESG ETFs

Energy — a sector that many ESG ETFS either underweight or outright exclude — is the best-performing group in the S&P 500 in 2022. Conversely, some of the sectors that ESG funds often heavily lean into, such as communication services and technology, are among the worst-performing groups this year.

“At the end of April, the S&P 500 was down more than 13% for the year. Large-cap growth stocks had declined 29%. With many sustainable equity funds tilted in that stylistic direction, sustainable fund investors are bearing the brunt of this downturn,” notes Morningstar analyst Jon Hale. “And because so many have only recently invested in sustainable funds, this is their first encounter with poor performance.”

Still, there’s a case for ETFs such as the SPDR S&P ESG ETF (EFIV). EFIV, which tracks the S&P 500 ESG Index, features similar sector exposures to the S&P 500, and while that’s not perfect in the current market climate, at least the fund isn’t excluding some of the better-performing sectors.

Likewise, with the significant drawdowns experienced by growth stocks in 2022, some of those names, including some EFIV components, may be offering value. That could be a sign that EFIV is an ETF to consider by investors positioning for an eventual growth equity rebound.

Another, longer-ranging factor to consider is the point that many companies are only now scratching the surface of potentially compelling ESG-driven changes.

“Meanwhile, take note of the fact that sustainable investors continue to successfully engage with companies on improving their sustainability performance and to support ESG-related shareholder questions at company meetings,” adds Hale. “Significant outcomes on climate-risk disclosure, racial audits, and plastics and packaging have occurred already in this year’s proxy season, for example.”

EFIV holds 308 stocks, many of which are tied to corporations already driving ESG change, including climate activism. Overall, EFIV offers ESG-oriented investors some attractive traits, but market participants new to this style of investing should not expect products like EFIV to move up in straight-line fashion.

“While sustainable investing includes a range of specific approaches, no sustainable fund is going to outperform all the time. The long-term thesis remains that, on balance, companies that embed sustainability into their operations, human capital, and governance will prosper more than those that don’t as we move through the first half of the century,” concludes Hale.

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