Even though shares of Tesla Inc. (TSLA) enjoyed a remarkable run during the global Covid-19 pandemic, the company has spent most of 2022 stalling out.
Tesla dropped 11% in one notable session in January, and the stock is down more than 13% year to date. Production delays have pushed back the debut of its much-hyped Cybertruck, higher costs have hurt the company’s bottom line and established auto giants have made real progress with their own electric vehicles.
Tesla’s rough spot is representative of the larger ESG investing trend, which has struggled to find its footing in 2022. The iShares MSCI USA ESG Select ETF (SUSA), one of the most popular ESG funds, is down nearly 9% so far this year—a sight worse than the S&P 500’s year-to-date loss.
The underperformance serves as a warning of how ESG names and their friends in the growth stock sector may fare when the Federal Reserve raises interest rates to fight the hottest inflation seen in four decades. As money becomes more expensive, investors may balk at growth and ESG stocks, which rely on cheap, easy funding.
And if ESG funds do struggle, just how patient will investors be?
ESG Could Be a Low-Energy Trend in 2022
For many ESG investors, Tesla represents the future. And while this company of the future has struggled, others that look more like the past are flourishing.
Take Exxon Mobil Corp (XOM), the Irving, Texas-based fossil fuel behemoth. Exxon is the biggest public energy company on earth, and its stock had barely gained in the decade or so after the peak of crude oil prices in 2008—a period characterized by massive investments in renewable energy, capped off by pandemic oil market crash in the spring of 2020.
Shares of Exxon had trailed the broader stock market by approximately 12 percentage points annually over that period. But since the bottom of the Covid crash of early 2020, Exxon has flourished. The stock is up almost 30% year to date, and it’s up more than 60% over the past 12 months. Compare that to the S&P 500’s 6% decline year to date and its 13% gain over the past 12 months.
Surging energy prices mean that Exxon and the rest of Big Oil are sitting on piles of cash. Shareholders are already starting to see increased dividends from the best energy stocks, a welcome occurrence in a time of high inflation and low bond yields.
“Dividend-paying energy companies aren’t anything new, of course,” wrote Morningstar’s Lauren Solberg in an article explaining the energy sector’s recent dividend largess. “What is new is that in recent years, the sector has seen a rush of companies initiating dividends for the first time—and existing dividend payers sharply boosting their payouts.”
There’s a good reason investors are bullish on companies like Exxon: Oil prices are up…a lot. In April 2020, a barrel of oil went for about $20. By February 2021, it was closer to $60. Today Brent crude oil prices are north of $90.
Demand for oil has climbed as economic activity ramps up. Meanwhile, renewable energy failed to meet the needs of many consumers last winter.
The picture gets more unfavorable for ESG performance when you look at clean energy stocks. For instance, iShares Global Clean Energy ETF (ICLN), which tracks the performance of leading renewable energy companies, is down almost 40% over the past year. The run-up in investor interest flamed out at the beginning of 2021 and hasn’t rebounded.
ESG’s Biggest Problem: the Federal Reserve
Rising energy prices are a key driver of the 40-year highs in CPI inflation. But even when you strip out energy and food, prices are still at historically high levels. That’s why the Federal Reserve has promised to raise interest rates and eventually excise trillions of bonds from its balance sheet.
The Fed’s new inflation-fighting stance hit stocks hard at the beginning of 2022. Some of the biggest losers were fast-growing technology companies that tend to suffer when interest rates rise. In 2022 so far, Snap Inc. (SNAP) and Netflix Inc. (NFLX) are down 33% and 27%, respectively. Both score well on ESG metrics are owned by the MSCI USA ESG Select ETF.
And since ESG funds tend to trade at a higher price-to-earnings ratio than the market overall, investors are more susceptible to volatility and lower future returns than if they had parked their money in a vanilla, unthemed index fund.
What Does Weak ESG Performance Means for Your Portfolio?
Proponents like to emphasize that ESG is a broad tent, and that not all ESG investors share the same goals. The ESG template, according to this argument, allows investors to understand how exposed a particular company is to various environmental, social and governance risks.
As the theory goes, companies that don’t have a large carbon footprint, treat their employees well and have competent management will outperform the market over the long haul. It’s no wonder, then, that Exxon doesn’t score well.
But just because your particular investment strategy’s message dovetails with your beliefs on the need to reduce carbon emissions doesn’t mean it’ll actually deliver strong investment returns.
Putting aside other issues with ESG, such as higher fees than average, investors need to realize that companies with less than stellar environmental impact can and will deliver high investment returns, especially when they’ve been undervalued.
Making a bet one way or the other, rather than relying on a truly passive investing approach that seeks to mimic the entire market, not just the ESG-friendly parts of it, leaves you open to being left behind.
Source: Forbes
