Opinion: Value-oriented ESG funds can be counted on one hand. That’s painful for investors as the technology melts away

Value stocks have significantly outperformed growth stocks this year as the Federal Reserve turned off the funds. But investors stand little chance if they’re looking to buy an environmental, social, or governance fund that leans toward this style.

Many ESG investors underperform the broader market for a number of reasons: Funds in this niche are underweight the sectors driving market dominance, primarily fossil fuel companies, which are considered value play due to their low valuations. ESG funds are often overweight the technology sector, which is in a bear market.

When it comes to value ESG funds, their options are severely limited.

Only five mutual funds and exchange-traded funds are explicitly value-oriented, and four are index funds: Nuveen ESG Large-Cap Value ETF NULV,
Calvert US Large Cap Value Responsible Index CFJAX,
and Praxis Value Index Fund MVIAX,
A fifth, Parnassus Endeavor PARWX,
is an actively managed mutual fund.

More than 550 sustainable funds are available to US investors, according to to Morningstar, but the vast majority are growth-oriented strategies, or a mix of growth and value but growth-biased due to market cap weighting.

The meager supply of ESG value funds isn’t surprising considering the style hasn’t been popular for so long. Todd Rosenbluth, head of research at ETF Trends, says value ETFs have been unpopular in recent years as the Fed kept interest rates low and tech stocks were boosted. He says the ESG ETF universe is still a relatively young category in terms of product development.

A cross-check of the sector holdings of the four index-based value funds shows that they are all underweight energy relative to their peers, with the large value category energy weighting around 7%. The biggest laggards among these funds are the Pimco and Calvert funds, which hold less than 0.5% in energy.

Photo credit: Morning Star

Give up performance for values?

Traditional value-added sectors such as energy and utilities are often heavily weighted by fossil fuel companies or companies with high carbon emissions. When these sectors perform well, as they are doing now, ESG investors who avoid these types of companies may have to settle for underperformance.

Rosenbluth is quick to point out that this doesn’t mean these sectors are always favored, even in value-driven market cycles.

“Even within the value sphere, there’s likely to be market rotation,” says Rosenbluth. “But if you own one of these, you might be disappointed that they don’t fare as well in this environment because of what they lack.”

But the near-term dampening of performance may not matter to ESG investors.

“I think investors in ESG products should be willing to forego some of the benefits because they prioritize companies that adhere to certain standards across all three of these pillars of ESG. If they wanted benchmark-like performance, they could just own the traditional benchmarks,” he says.

Jordan Farris, head of ETF products at Nuveen, says the firm’s ESG value fund has the most assets under management (AUM) of its 18 total ETFs, both ESG and non-ESG ETFs. This year alone, through May 1st, the ESG value fund saw $200 million in inflows.

Their suite of ESG ETFs was built to include names that were in the top 50% in each sector, and Nuveen imposed a low-carbon criterion to measure weighted average carbon emissions intensity versus non-ESG – to reduce products. In addition, sector weights are optimized to plus or minus 4% relative to the parent index to reduce tracking error. This helps ESG ETFs to be relatively close to industry representation compared to non-ESG ETFs.

Nuveen’s ESG value ETF has a 3.8% weighting for energy and includes names such as Halliburton HAL,
and Sempra Energy SRE,
Still, Farris says her ESG Value fund’s weighted average carbon intensity is lower than its peers. Morningstar calculates a carbon risk score for funds ranging from zero to 100, with 100 representing the highest risk. It shows Nuveen’s ESG Value fund carbon risk score of 7.28 versus the category average of 10.28.

“I would consider this an enhancement product rather than an absolute product. What we’re aiming for here is a higher ESG score and lower carbon emissions intensity with a very similar risk and reward profile to a standard non-ESG value index,” says Farris.

Look outside the funds

Jeff Finkelman, Managing Director of Sustainable Investments at Fiduciary Trust International, says that while ESG funds are currently underperforming, it’s important to keep a long-term time horizon in mind when thinking about sustainable investing as trends related to social issues, climate change and the inevitability of an energy transition will not go away.

Rather than looking at funds, investors may need to consider individual sectors, Finkelman says, suggesting companies in recycling, waste management, chemicals or industrial processes.

“These are the areas where ESG issues might be even more important over time as these long-term trends take hold,” he says. Opinion: Value-oriented ESG funds can be counted on one hand. That’s painful for investors as the technology melts away

Brian Lowry

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