The performance of sustainability indexes varied widely in 2024, according to a report by Morningstar Indexes.
On the one hand, climate indexes had a “banner year”, powered by exposure to Nvidia, Tesla, and other members of the “magnificent seven” - Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla.
On the other hand, impact-aligned indexes - which generally select and overweight companies that contribute positively to the planet or society struggled, relative to the broad market.
Morningstar Indexes reports on the relative risk/return profiles of a range of sustainable investing approaches annually.
In 2024, the relative performance of sustainability indexes improved compared with 2023 and 2022 but lagged from 2021 and 2020.
Climate-focused indexes led the way, but only 45 per cent of all sustainability indexes outperformed their broad market equivalents in 2024.
Morningstar said investments centered on environmental, social, and governance factors generally performed better during periods when less carbon-intensive sectors, such as technology and communication services, led equity markets.
Concentration in global equity market leadership in 2024 led to uneven performance across sustainability indexes.
The report said: “Many of these indexes use a best-in-class selection methodology, meaning they include only the highest-rated stocks based on ESG risk within each sector. Since recent top market performers have been concentrated in just a few sectors, this approach often results in missing out on certain high-return securities.
“In these cases, the underperformance of sustainability indexes is driven more by idiosyncratic risk than systematic risk.
“It is important to note that sustainable investing is not monolithic, which becomes more apparent when looking at the dispersion of returns within Morningstar’s sustainability index ranges. Approaches vary in motivation, implementation, and application.”
The report went on to say that indexes using ESG risk-focused security selection or tilting weight mechanisms slightly underperformed the broad equity market in 2024.
The paper explained that climate Indexes, which use similar mechanisms but largely use emissions intensity or forward-looking climate metrics, largely outperformed the market in 2024.
Similar to 2023, underperformance in 2024 was primarily driven by security selection.
The report added: “Magnificent seven members Meta Platforms and Alphabet faced serious ESG controversies, while Tesla and Amazon had higher ESG risk relative to their sector peers, leading to either exclusion from or unweighting in many ESG risk-focused indexes.
“Impact-aligned indexes continued to underperform after the pandemic due to high exposure to struggling industries like solar, chemicals, and biotechnology.”
