ESG shares underperform oil and gas in 2021

Oil and gas shares — knocked early in the pandemic and increasingly shunned by eco-conscious investors — have this year eclipsed the stock markets’ in-vogue environmental, social and governance-focused companies.

As of December 29, US giants Exxon and Chevron had added 48 per cent and 40 per cent respectively in 2021. The duo have helped power global energy equity funds past many of the hundreds of US and European sustainable funds as defined by Morningstar, a data provider.

The iShares MSCI global energy producers exchange-traded fund is up 37 per cent to December 29, outperforming the largest US ESG fund — the $31.8bn Parnassus Core Equity fund - which is up 28 per cent. The largest iShares ESG fund run by giant fund manager BlackRock has also trailed, up 30 per cent.

It marks a sharp change from 2020, with the more tepid performance leading to early signs that investor enthusiasm for ESG funds has cooled, as investor inflows into the fund class have slowed from their breakneck pace at the beginning of the year.

“Cyclicals tend to be dirty stocks,” said Pierre-Yves Gauthier, head of strategy at AlphaValue, a Paris-based independent research firm. “The dash for cyclicals came very early in 2021 and never stopped,” he added. “That came at the cost of the very expensive green stocks, which were leading the show in 2020. It was a crowded trade last year.”

The Invesco Solar ETF and the iShares Global Clean Energy ETF are down more than a quarter this year. In contrast, these funds’ share prices tripled and doubled, respectively in 2020, when Exxon plummeted 41 per cent and Chevron fell 30 per cent.

Danish power group Orsted “was the darling” for ESG funds in 2020, Gauthier said. But Orsted and wind turbine maker Vestas have warned of challenging conditions in renewable energy after projects in Europe suffered low wind speeds and higher costs hit manufacturers.

Orsted and Vestas have dropped by around a third in 2021. Iberdrola, the Spanish utility that has also prioritised renewable electricity, is down around a tenth this year.

Meanwhile, despite volatility in the oil price following the emergence of the Omicron coronavirus variant last month, Brent crude and the US benchmark WTI are both up by more than a half in 2021.

Global oil demand is on track to surpass 2019 levels by March 2022 and is projected to continue its rise in 2023, according to JPMorgan.

“We are seeing the first energy crisis of the decarbonisation era,” said Joyce Chang, chair of global research at JPMorgan. “ESG overperformed because natural energy underperformed in 2020.”

ESG funds have benefited in the past by typically taking outsized positions on high-flying technology holdings such as Microsoft, which is the most widely held stock in US ESG funds, according to Bank of America, and is up by more than a half this year. At the same time, ESG funds are typically underweight energy names — if they are included at all. But energy has been the top-performing S&P 500 sector this year, marking a 50 per cent rise in 2021.

ESG investing has also drawn unprecedented scrutiny in 2021. Tariq Fancy, BlackRock’s former global chief investment officer for sustainable investing, observed that ESG offered asset managers a way to sell higher-fee products with little, if any, environmental benefit.

Performance this year may have damped investors’ interest in sustainable vehicles, with European ESG funds’ inflows slowing to $108bn in the third quarter — down from $149bn in the first three months of 2021 — according to data from Morningstar Direct. In the US, ESG fund flows peaked at $22.6bn in the first quarter but dropped to $15.7bn in the third quarter.

The fund flows slowdown hit as asset managers were investing in new ESG products. A record 38 US sustainability funds launched in the third quarter of 2021, topping the 30 funds unveiled in the third quarter of 2020, Morningstar said.

Some analysts remain optimistic about ESG, noting that the Thrift Savings Plan, the largest US retirement plan with $760bn in assets, has said it will offer ESG funds in 2022. And the Labor Department is expected to finalise a rule that would open the door for companies to offer ESG funds in retirement plans.

ESG funds “didn’t have the dramatic outperformance that they had in 2020,” but “we will likely see continued emphasis on ESG funds and ESG integration going into 2022,” said Michelle Dunstan, chief responsibility officer at AllianceBernstein. “We see this as a long-term secular trend.”

“It took oil and gas outperforming ESG this year for investors to understand that this [ESG] is a much more nuanced space than they initially thought it was”, said Aniket Shah, global head of ESG research at Jefferies, a US investment bank.