Marlies van Boven
Alberto Allegrucci
Despite their historically high correlations and low tracking errors, Sustainable Investment (SI) index returns in most markets have strayed quite markedly from those of their respective benchmarks over the past tumultuous year.
A particularly strong case in point has been the UK. As we highlight in our latest Sustainable Investment Insights report, most UK SI strategies lagged the benchmark in 2022, with significant divergences across strategies, despite the UK strongly outperforming its developed-market peers for the period (with a gain of 4.9%).
Equity benchmarks and Sustainable Investment indices* (TR,LC%) - 2022
Source: FTSE Russell. * ESG Low Carbon Target, Choice = Global Choice, EnvOps = Environmental Opportunities. See link above to our latest report for a full list of the FTSE Russell Sustainable Investment indices. Data as of December 31, 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
Among the UK SI strategies, Environmental Opportunities was the biggest laggard for the period, trailing its benchmark by 16.9 percentage points. The Paris-Aligned, the Climate Transition and the ESG Low Carbon Target indices were also major underperformers, lagging by 15.5, 10.9 and 11.4 points, respectively. ESG-focused FTSE4Good and Global Choice UK returns were roughly in line with the UK market.
UK SI index relative returns vs the FTSE UK - 2022
Source: FTSE Russell. Data as of December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Why did UK SI return patterns diverge so greatly from those of their counterparts in other markets? Differing Energy exposures played a major role. Most SI strategies are underweight Energy stocks, either directly because their selection methodology explicitly excludes them (e.g., the EU benchmarks, such as the Climate Transition and Paris-Aligned) or indirectly (e.g., the green-tech-focused Environmental Opportunities).
Accordingly, the spectacular runup of Energy stocks in 2022 has been a significant drag on relative SI performances. This was particularly true in the UK, where the industry accounts for roughly 13.5% of the UK benchmark, almost three times its weight in the FTSE Europe ex UK and FTSE All-World ex UK, respectively.
Industry weights and contributions to YTD returns )TR,LC%) - 2022
Source: FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Oil stocks and prices have gone separate ways
As the graphic below illustrated, while crude oil prices have been falling since June, Energy stocks have seen renewed strength in recent months, supported mainly by these companies’ record-breaking quarterly profit reports. Oil, gas and coal stocks drove most of the industry’s recent gains, though alternative energy stocks have made headway since mid-year.
Global Energy sector returns (rebased, TR, LC) vs crude oil price (USD, RHS)
Source: FTSE Russell. Based on Industry Classification Benchmark (ICB) data through December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The two charts below illustrate the impact of industry allocations on UK SI performances over 2022. As shown, the biggest strains on returns across strategies (except for UK Choice) have come from large underweights to outperforming Energy, despite its feeble gains during the last months of 2022. Overweights to underperforming Telecom stocks were another significant detractor for ESG Low Carbon, Climate Transition and the Paris-Aligned benchmarks, while Environment Opportunities’ overweight to the industry was modestly additive.
UK SI indices – Active industry weights and allocation effects – 2022 (TR, LC %)
Source: FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Oil prices to remain an overhang on SI returns in 2023
Given the continuing supply/demand constraints resulting from the ongoing Russia/Ukraine war, European Union price caps and the unclear impact of China’s Covid-19 policy on the economy, it is uncertain whether oil prices will revert to levels seen pre-pandemic. Although futures prices have declined, they are still above year-ago levels, even at the far end of the curve. Oil price moves do not necessarily imply same-direction movements in energy stock prices, but the latter is likely to continue to hold sway over SI index performance in the UK and globally in the year ahead.
Brent oil futures settlement price curve (USD)
Source: FTSE Russell / Refinitiv. Data through December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Valuations for both UK Energy and Telecom appear supportive, both relative to the benchmark and their long-term averages. Despite the 2022 rally, UK Energy remains the cheapest stock group based on 12-month-forward EPS estimates, while the sell-off in Telecom stocks has pushed the industry’s forward P/E well below its historical norm.
FTSE UK 12-month-forward P/E multiples
Source: FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Notably, Energy currently carries a 12-month-forward dividend yield of around 4%, significantly below its 10-year average but in line with that of the benchmark, while Telecom is paying the highest forward dividend yield, which at 8.6% is significantly above its historical average of 5.6% and that of the benchmark.
FTSE UK 12-month-forward dividend yields (%)
Source: FTSE Russell. Based on Industry Classification Benchmark (ICB) data as of December 31, 2022. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
To read more details on this and other related topics, check out our latest Sustainable Investment Insights report.
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