The Takeaway
In calendar-year 2021, 66 of Morningstar's 116 ESG indexes (57%) outperformed their non-ESG equivalents, down from 75% ESG outperformance in 2020.
Over the five-year period ended Dec. 31, 2021, 88 of the 110 (80%) Morningstar ESG indexes with five-year histories outperformed.
Sector tilts, security selection, and other factors like geographic allocation and yield-curve positioning all help explain ESG index performance. Mixed results in 2021 can be partly attributed to the fact that the best performing global equity sector was energy––though technology also performed well.
"Sustainable investors should neither expect to always outperform nor to always underperform, but they should expect investment returns that are competitive with those of conventional investments," wrote Jon Hale, Morningstar's head of sustainability research. 1 Hale's statement is an important level set. Investing based on environmental, social, and governance criteria does not necessarily require a return sacrifice, as is sometimes assumed, but neither is it a guaranteed route to market-beating performance. What is certain is that any deviation from a market portfolio will produce a different outcome. Studying past behavior can help guide sustainability-focused investors going forward.
Sustainable investors should neither expect to always outperform nor to always underperform, but they should expect investment returns that are competitive with those of conventional investments
Since 2018, we have published an annual study gauging the performance of Morningstar's ever-growing range of ESG indexes. Short- and longer-term returns are examined for both equity and bond indexes. Observers will note that the track record of most sustainable investments is limited; ESG is still evolving in terms of methodology and data availability, and years of technology sector leadership of equity markets has provided a tailwind. Even so, examining the behavior and the complexion of Morningstar's ESG indexes—and their changes through time—can shed light on a burgeoning field.
It's also critical to look at risk in addition to return. Risk characteristics tend to be more stable over time than returns, which are highly changeable depending on market conditions. Also, the Sustainalytics ESG Risk Rating, the foundation for many Morningstar indexes, is focused on material financial impact. So, the ability of those indexes to mitigate risk can help gauge the rating's efficacy.
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