Wall Street Math Shows ESG Funds Can Ride the Value Stock Boom

(Bloomberg) -- Green funds have gained a reputation of benefiting from the tech rally during the pandemic. As the economy recovers and investors shift to cheaper stocks, those products might still be able to thrive.

Relative to the S&P 500, funds that track companies that meet environmental, social and governance standards have more exposure to cyclical sectors than the broader industry, according to a Bank of America analysis. Those U.S.-domiciled ESG products are overweight industrial, raw-material and real-estate shares, while mutual funds in general are underweight those groups.

“One of the key pushbacks we often get from investors is that ESG benchmarks have outperformed because they are overweight tech and growth stocks,” said Marisa Sullivan, head of U.S. ESG research for Bank of America Global Research. “We found they are overweight a lot of cyclical sectors, so maybe they aren't as poorly positioned for a value rotation.”

ESG funds have avoided the growth-oriented consumer services sector, according to the study, and have raised their exposures to energy and utilities in recent months -- although they are still underweight those industries.

“There's a little bit of a misconception that everything ESG-oriented has to be growth or tech heavy,” said Omar Aguilar, chief investment officer of passive equity and multi-asset strategies for Charles Schwab Investment Management. “The evolution of these ESG strategies is still in flux, and the makeup of these ESG strategies will be a key part of how they evolve this year.”

Still, the biggest ESG products do have substantial stakes in tech companies. The largest mutual fund in the category -- the $24 billion Parnassus Core Equity Fund -- is made up of 15.7% software firms, its top industry group, followed by 13.2% semiconductor stocks.

BlackRock's iShares ESG Aware MSCI USA ETF (ESGU) -- the biggest ESG exchange-traded fund with $16 billion in assets -- counts Apple Inc., Microsoft Corp., Amazon.com Inc., Alphabet Inc. and Facebook Inc. as its largest holdings.

For the ones that rely strongly on tech, the increase in Treasury yields has the potential to hurt performance, according to some analysts.

“Those ESG funds that are heavily allocated to those growth-oriented stocks where their value is dependent on the value of their future cash flow, they'll be super sensitive to what happens with longer-term interest rates,” said Tom Hainlin, national investment strategist at U.S. Bank Wealth Management.

©2021 Bloomberg L.P.