Update

One month in, sustainable funds show they can handle a bear market

Here’s my latest update on how sustainable equity funds are holding up during the bear market. At the one-month mark since the market peak on February 20, sustainable equity funds continue to hold their own on a relative basis. To be sure, these funds have experienced gut-wrenching declines along with all equity funds, but they have outperformed conventional funds on a relative basis.

Peer Groups Comparison

I compared the trailing one-month and year-to-date returns of all 203 sustainable equity open-end and exchange-traded funds available in the U.S. with those of their respective peer groups. For peer groups, I used Morningstar categories, which group similar funds based on portfolio characteristics like region, market cap, and style. Categories contain funds with sustainable mandates as well as conventional funds, with the latter making up the vast majority within each peer group.

For the trailing one-month period, from February 20 to March 19, the returns of two thirds, 67%, of sustainable equity funds ranked in the top halves of their respective Morningstar categories. More than a third, 38%, ranked in their category’s best quartile while only 11% ranked in their category’s worst quartile. That means sustainable funds are overrepresented in the top quartiles and top halves of their peer groups, because, by definition, 25% of all funds in each category place in each of four quartiles. More than three times the number of sustainable funds land in the top quartile of their category than in the bottom quartile.

Broadening the perspective to this year through March 19, the relative outperformance of sustainable equity funds is even better. The returns of 7 of 10 sustainable equity funds ranked in top halves of their respective categories. The returns of 40% ranked in their category’s top quartile while only 8% landed in their category’s worst quartile. In other words, five times as many sustainable funds ranked in their category’s top quartile than in the bottom quartile.

Index Funds Comparison

I also compared the returns of 26 ESG index funds with those of conventional index funds covering U.S. stocks, non-US developed-market stocks, and emerging-markets stocks. Over the last month, 19 of the 26 outperformed conventional index funds, and 24 have outperformed for the year to date through March 19.

U.S. While most passive ESG funds found in the Morningstar Large Blend category had been leading the S&P 500 in my earlier performance updates, they have faltered a bit during the past week. For the one-month period ending March 19, five are outperforming iShares Core S&P 500 ETF (IVV), and seven are trailing. The average ESG passive fund return, however, remained a bit better than IVV’s return (-28.53% v. -28.71%), and all but two ESG passive funds rank in the top half of the category.

For the year through March 19, 10 of the 12 ESG index funds are outperforming IVV. Their average return is a full percentage point better than that of IVV, and all rank in the top half of their category.

These returns are net of expenses and thus take into account the higher expense ratios of the ESG funds. IVV has an ultralow expense ratio of 0.04% while the expense ratios of the dozen ESG passive funds range from 0.10% to 0.25%, and average 0.16%.

The top performing ESG fund for the past month is iShares MSCI USA ESG Select ETF and for the year to date, IQ Candriam ESG US Equity ETF.

Developed Markets ex-U.S. Outside of the U.S., every one of the ESG index funds is outperforming so far during the bear market. All 11 passive ESG funds in the Morningstar Foreign Large Blend category outperformed iShares Core MSCI EAFE ETF (IEFA) for the month ending Mar. 19. While IEFA lost 32.09%, the average ESG passive fund return was -30.15%. And, for the year through March 19, all 11 ESG index funds are outperforming IEFA. Their average return of -30.05% is well ahead of IEFA’s -32.75% return.

As with the comparisons of U.S. funds, these returns are net of expenses and thus take into account the higher expense ratios of the ESG funds. IEFA has an expense ratio of 0.08% while the expense ratios of 11 ESG passive funds range from 0.14% to 0.98%, and average 0.34%. Five funds have expense ratios between 0.14% and 0.20%.

The top performing passive international ESG fund for both the past month and the year to date is Green Century MSCI International Index. It’s also, by the way, the most expensive fund on the list, but it’s worth noting that Green Century Funds is owned by a group of non-profits that focus on environmental and public health.

Emerging Markets. The three emerging markets ESG index funds outperformed iShares Core MSCI Emerging Markets ETF (IEMG) over both periods. They posted an average return of -29.56 for the month ending March 19, which is 1.59 percentage points better than IEMG’s return. For the year to date, the three ESG funds have outperformed IEMG by an average of 1.8 percentage points. The ESG funds also had to overcome higher expenses (0.20%, 0.25%, and 0.40% compared with IEMG’s 0.14%).

Given the size of the stock-market decline over the past month, the difference between the returns of sustainable funds and conventional funds may seem trivial. And I do think we tend to make too big of a deal about whether a fund outperforms or underperforms a benchmark when the difference is often only a few basis points.

But, as I’ve pointed out in my earlier updates, most of the growth of sustainable investing has taken place since the global financial crisis, much of it in the past five years. That means most ESG funds have not been put through the stress test of a bear market until now. One month into it, they’re definitely hanging in there.

Keep in mind, too, the bigger picture, one that I think will be strengthened in the aftermath of this global pandemic. Sustainable investing is about delivering competitive financial performance while also helping move toward a more long-term-oriented stakeholder-centric version of corporate behavior. When all is said and done, I think we’ll find the companies that are already moving in that direction will be the ones we’ll remember for helping us get through this crisis.