The Case for ESG Funds During Volatile Times: Morningstar

Advisors wary of sustainable investing may want to consider the performance of environmental, social and governance focused funds during these volatile times.

According to a new report from Morningstar, many funds investing in companies with relatively high ratings for ESG factors "prove to be more buoyant" than comparable non-ESG funds during market declines.

ESG funds tended to capture less of the downside of their Morningstar benchmark and to experience less volatility than comparable non-ESG funds during market drops. They have also been helped by "a significant underweighting of energy stocks."

Moreover, within the ESG fund category, funds with higher Morningstar sustainability ratings outperformed those funds with lower sustainability ratings.

The Morningstar findings were similar to those released by S&P Global Market Intelligence found in a report published in May. That report analyzed the performance of 17 exchange-traded and mutual ESG funds with more than $250 million in assets year to date through May 15.

Morningstar analyzed more than 137 funds across 19 investment categories with $50 million or more in assets over one, three and five years though March 31, which captured some but not nearly all the market volatility during the COVID-19 pandemic. (Funds with less than three-year track records were excluded.)

Comparing Downside Capture and Standard Deviations

Through the year ended March 31, the median ESG fund captured almost 12 percentage points less of its category benchmark's decline than the average fund in that category. (Nine categories were included in this part of the analysis.) Over three years, the difference narrowed to just over 9% and over five years, slightly above 6%.

When Morningstar compared the funds with the highest sustainability ratings — earning four and five globes — the differences were even greater.

The median highly rated ESG fund captured 18% less of its benchmark category's decline over one year, nearly 11% less over three years and about 9% less over five years.

Morningstar also compared the standard deviations for returns of ESG funds to those of the average fund in its category over the same time frames to measure their volatility. There it found the median ESG fund experienced a lower standard deviation of 0.93 and 0.59, respectively, over one and three years. Over five years, however, ESG funds had a 0.14 higher standard deviation.

The Standouts

Two ESG funds outshone the rest, both from firms that have long focused on sustainable investing: The Parnassus Core Equity Investor Fund and Calvert Equity Fund.

The Parnassus Core Equity investor captured just 75.5% of the market downturn through March 31 compared with the 94.6% capture of its average large blend fund category. The Calvert Equity Fund outperformed its category average by 39 percentage points for the year ended March 31.

"The ESG story is becoming more compelling," the Morningstar report concludes, noting the downside cushioning these funds provide over the short and long term and their ability to navigate investment risks posed by climate change and the COVID-19 pandemic.

— Check out ESG Fund Ratings: Not Perfect, but Still Valuable on ThinkAdvisor.