Sustainable funds outperform in returns and flows

Open-end and exchange-traded funds stood up well in a very down first quarter relative to their unconstrained peers. Research from Morningstar shows that 44% of all sustainable equity funds were in the top quartile of its broader equity universe and 70% performed above the median.

Among ESG-focused U.S.-equity index funds, 10 out of 12 were able to outperform the baseline iShares Core S&P 500 ETF by an average 1.37 percentage points, net of fees. All 11 ex-U.S. equity index ESG funds outperformed their baseline iShares Core MSCI EAFE ETF by an average of 1.89 percentage points.

A common them among several of the funds that outperformed were the relatively lower allocations to the energy sector. The baseline U.S. and international funds had energy exposures of 2.6% and 4.2%, respectively. The top five funds in each category had average sector allocations of less than half of their group's baseline fund.

This evidence brings into question whether or not the broader environmental, social and governance strategy is driving better returns, or whether it's an overall avoidance of energy. The S&P 500 Energy index lost more than 50% in the first quarter as the price of crude oil plummeted below $30 a barrel.

Investors, however, flocked to ESG funds during the first quarter. Sustainable ETFs added a net $7.8 billion in the first three months of 2020, or 40% of all equity ETF flows. ESG mutual funds had a net $2.7 billion of net inflows during the quarter, even as the broader equity mutual fund category had net outflows of $5.7 billion.