Investors Trying to Bet on ‘Good’ Companies Are Trailing the Market

(Bloomberg) -- ESG investors’ dependence on technology and e-commerce stocks is beginning to weigh on their returns.

Shares in companies chosen for their adherence to environmental, social and governance norms are trailing the broader universe of equities in both the U.S. and emerging markets. An exchange-traded fund buying American ESG stocks posted the worst monthly underperformance since August 2019, while a similar fund focusing on the developing world saw short sellers raising their bearish bets to a record high.

The stalling of ESG returns coincides with a selloff in U.S. technology shares, just as their rallies coincided earlier this year. A closer look at the composition of ESG portfolios shows why; They are reliant on technology and e-commerce stocks. That suggests sustainable investing is still in its infancy, having to rely on virtual business models, while many traditional industries fall short of the required standards.

The $8.9 billion iShares ESG Aware MSCI USA ETF, dominated by the likes of Apple Inc. and Microsoft Corp., has dropped more than 5% in the past five weeks. That sent its price ratio with the SPDR S&P 500 ETF Trust to the first monthly drop since February.

The losses have coincided with a 5.7% decline in the Nasdaq 100 in September, and a 1.1% drop this month.

In emerging markets, the $3.8 billion iShares ESG Aware MSCI EM Exchange-Traded Fund is experiencing a similar reversal. Its top 10 holdings are all either software, online-shopping or tech-enabled businesses, which fueled a 49% surge between March and August. The fund has drifted since then, losing 2% and reducing its price ratio with the iShares MSCI Emerging Markets ETF. The Nasdaq 100 gauge has lost almost 6% in the period.

The EM ESG fund’s top-owned stock, Alibaba Group Holding, has slipped almost 2% from its record high on Sept. 1, while Tencent Holdings, the second-biggest, is more than 5% off its high on Aug. 6.

Short sellers have wagered $113 million calling for a decline in the ETF, the most since its inception more than four years ago.

It’s not that only ESG portfolios are dependent on technology stocks. Almost 28% of the U.S. equity benchmark comes from the sector, with consumer-discretionary shares accounting for another 12%. The two groups account for 39% of the MSCI Emerging Markets Index, making it heavily reliant on online-business fortunes.

While that leaves equity markets in both the U.S. and emerging markets vulnerable to a tech selloff, the cushion the broader indexes have with their exposure to other sectors (health care in the U.S., commodities in EM) aren’t present in ESG portfolios.

Unless traditional industries start to score highly on ESG metrics, sustainable investing remains a proxy for technology bets.

©2020 Bloomberg L.P.