Sustainable funds with the highest returns in a down year

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 U.S. open-end mutual funds and ETFs had seen positive total returns, according to data provided to 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 U.S. funds Morningstar categorizes as sustainable.

The sustainable funds that are leading the pack on year-to-date returns “are sort of getting the side effects of the energy rally,” said 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 said.

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 Aug. 3, 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 said.

However, 32% of funds in Morningstar’s sustainable category ranked in the bottom quartile among peers for performance, she noted.

“It does appear that sustainable funds are faring worse,” due in part to high allocations to communications and tech, she said.

Fourteen percent 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. U.S. sustainable funds saw net outflows of $1.6 billion 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 U.S. funds — sustainable or otherwise — net outflows for the second quarter stood at $150 billion.

THEIR 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,” said Rene Reyna, head of thematic and specialty product strategy for Invesco.

The $2.3 billion 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 said.

“The share prices were getting well ahead of fundamentals. We started to see reversals post-election,” he said. 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 said.

The product, 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, he said.

Recently, two Democratic holdouts on the energy plan — Sens. Joe Manchin of West Virginia and Kyrsten Sinema of Arizona — have changed their minds on support for climate, tax and health care legislation, which if passed could provide immense funding for clean energy initiatives.

“It’s going to be the single biggest climate investment in U.S. history,” Reyna said, describing the legislation as “icing on the cake” for solar.

OTHER PERFORMANCE LEADERS

By total returns, the top performing 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.

That product, launched in December 2021, appears to be the first sustainable long-short U.S. 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 said in an email. However, the fund has also seen stronger returns from stocks with good performance on ESG metrics, it said.

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 said.

The largest sustainable U.S. mutual fund on the market, the $27 billion 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 said.

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 noted. “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 said.

“This is one of the benefits about being clear on our approach to sustainable investing relative to fossil fuels,” Allen said. “In the last 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 story was originally published on ESG Clarity.