Last year was a tough one for ESG investors, with a near perfect storm of headwinds resulting in below par performance for UK ESG funds, and only a few managing to deliver first quartile performance. This has led to a challenging landscape for ESG investors.
During the year, the FTSE All-Share’s performance climbed back to its pre-pandemic high, but this recovery was led by sectors that in the main are eschewed by most ESG investors. This included aerospace and defence (+19%), mining (+36%), beverages (+40%), and oil and gas (+32).
The main drivers of outperformance in these avoided sectors are linked to rising demand from consumers and supply chain constraints, as the economy begins to emerge from the easing of pandemic restrictions. The latter has been very much driven by a change in logistics management, which has moved from “just in time” to “just in case”, leading to a spike in demand for inventory. The pent-up consumer demand is now coming through all sectors of the economy leading to sharp increases in both soft and hard commodities.
The start of this year has been extremely difficult for all investors with very few areas of the market providing any shelter from the fallout for ESG investors. The near-term headwinds include a selloff in so-called growth names, mostly in the small- and mid-cap arena, which is a natural hunting ground for ESG investors.
The FTSE 100 is the only index that was in positive territory in January, with the small- and mid-cap indices in deep negative territory. The shift from small- and mid-cap names to more cyclical larger companies will become more prevalent in a rising interest rate environment, which is more likely as we see a surge of inflation in 2022.
However, long-term ESG investors should examine the performance of responsible and sustainable funds in the medium to long term where the performance holds up very well against the benchmark and non-screened UK peers. These periods of volatility and underperformance occur from time to time, but over the long term ESG funds have successfully navigated the storm.