By Lee Clements, head of Applied SI, Global Investment Research
- Sustainable investments (SI) bounced back strongly in Q1 2023 after a challenging year in 2022.
- Energy Efficiency was the best performer in the green equity market, while Renewable & Alternative Energy struggled.
- Despite the positive performance, caution is advised for the future as the market direction remains unclear and there are growing geopolitical tensions in the green economy.
After a challenging year for sustainable investments in 2022, as discussed in Has it been easy being green? Sustainable index performance in 2022 | FTSE Russell, they have strongly rebounded at the start of 2023. In Q1 most SI equity strategies outperformed the market, with a notable change in the performance leadership. FTSE Environmental Opportunities All Share, which tracks companies involved in the green economy, was the strongest outperformer in Q1, having been the weakest performer in 2022. Similarly, the FTSE4Good and FTSE ESG Low Carbon, the two best performers in 2022, were the worst performers in Q1 2023.
This was driven by the markets view on rates, growth and sustainable investments changing sharply at the turn of the year. It also shows that SI market has grown way beyond the single, homogenous investing style, as it is often portrayed in the media, to a broad, multi-faceted set of different strategies suited for not only different SI goals, but also different market regimes and risk appetites. This is great for choice and competition in the SI market and for those seeking diversification, whilst keeping true to their SI goals, however it does make the eternal question of whether SI is good or bad for performance very difficult to answer and has if anything now become a moot point.
There was also a turnaround in the performance of green equities vs energy equities, after two years of weak relative performance.
As well as a change in the overall direction of performance for SI funds in Q1 there was also a change in the green sub-sector performance within the green equity market. Energy Efficiency was the best performer in Q1 2023, which typically outperforms in cyclical upturns with exposure to technology and consumer discretionary, having been the worst performer. Renewable & Alternative Energy, the best performer in 2022, helped by the announcement of the US Inflation Reduction Act, but still to see the full extent of the financial impact, was the worst performance in Q1. More defensive Water & Waste sectors also underperformed relative to Energy Efficiency in Q1.
Whilst volatile, going from an “everything rally” in January to banking crisis in March, the macro backdrop was positive for SI in Q1. Falling global yields, stabilising economic data and the overall upwards direction of equity markets tend to be supportive for most SI strategies, particularly climate focused strategies which tend to be more growth focused.
In Q1 some of the key industry active weights in global SI strategies were positive for performance. Whilst the active industrial exposure can be quite variable between strategies, with both over and underweights in consumer discretionary, financials or healthcare, all the global SI strategies are overweight technology and underweight energy. These both gave positive industry allocation effects in Q1, as did being underweight Financials for Environmental Opportunities and PAB. Stock selection effects where less widely spread, positive in Consumer Discretionary and negative in Technology.
Despite the strength of the performance of SI in Q1 there should still be caution looking ahead as the overall direction of markets remains far from clear. Green investment should benefit from the hundreds of billions of dollars of support from the US Inflation Reduction Act and the EU Net Zero Industry Act they do come against a backdrop of growing geopolitical tensions in the green economy. The unwinding of large premiums in the green equity market were largely completed by the end of last year and both valuations and premiums started to creep up again in Q1, leaving particularly Environmental Opportunities and PAB at premiums above their 5-year average.
For more detail of the performance of SI equity indices in Q1 see Sustainable Investments Insights - April 2023 | FTSE Russell. For broader market outlook see Asset Allocation Insights - March 2023 | FTSE Russell, Subscribe to our blog.
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