It was a September to remember in the markets. The ESG Orphans Index fell 9% in September. No place was safe to hide. Even what we consider “safer” areas of the markets, lower beta, value names, dividend paying sectors, were not safe. It reminded us of the old adage, “When they raid the house of ill repute, even the piano player goes to jail.”

Certain sectors, especially some of the sectors that make up the ESG Orphans Index were hit hard. Utilities finally caught down to the rest of the market. The Dow Jones Utilities Index fell 12% on the month. Consider that prior to September, the Utilities Index was up nearly 3% YTD and it is now down more than 9% YTD. The ESG Orphans Index has 25% weight to the nuclear energy utilities and felt that pressure during the month.

The energy sector was no different. The SPX Energy Sector Index fell 9.7% during September. Crude oil fell 11% in the month. The ESG Orphans Index has 25% weight to fossil fuel and suffered as a result.

The Dow Jones Aerospace & Defense Index fell 10% during September. Weapons/munitions make up 21% of the ESG Orphans Index. Like those aforementioned energy and utilities sectors, the aerospace and defense sector traded poorly. There were no safe places to hide.

The other big component in the Orphans Index is alcohol and tobacco stocks at a 25% weighting. The leading tobacco names in the ESG Orphans Index fell in-line with the markets. The alcohol names fell a little less than the markets, a slight outperformer, but it did little to assuage the overall downside in the Orphans Index.

On the positive side, many of the securities in the ESG Orphans Index paid quarterly dividends in September and the indicated yield is near 3.5% now. In addition, see these YTD numbers for the various indices: SPX -25%, NDX -33%, NYSE Composite Index -21.5%, and Russell 2000 Index -26% versus the ESG Orphans still up 1.35% in 2022.

A big part of the reason for the outperformance of the ESG Orphans Index relative to the others is due to the Orphans being severely under owned relative to the broader markets. Our research shows a very overcrowded tech allocation in the market. Big cap tech tech makes up an inordinately large portion of many indices and portfolio baskets currently. The explosion in ESG funds, the massive bubble and flows we detail in our work, exacerbated volatility in the markets.

Many ESG proxies’ top 5 holdings look exactly like that of the SPX and the NDX. These are the big cap tech names that everyone knows. When markets get unstable, correlations go to 1. Everyone sells what they own too much of. They go after the most liquid stocks. It makes sense that stocks that are in the $1Tln-$2Tln range in market caps get sold. These are the generals that have led the army of stocks over the past decade. The generals have been wounded; the army is faltering.

A further headwind to these “growth” stocks is higher rates. Currently, the Fed has the inflation fighting as its first priority. Higher rates mean that valuations should come down on a relative basis. The current 2yr bond yields over 4.13%. That is up over 300bps since the beginning of the year. As far as risk and reward goes and what investors might prefer, if US Government risk-free (relatively) paper is yielding 4.13%, that means equities need to be considerably more attractive to garner investment funds. That’s part of the conundrum at this point.

Our ESG Orphans remain an important piece of the investing puzzle. Much of the exposure provided by ESG Orphans is in vital industries, not political ones. Nuclear energy is used by the US Navy for submarines and aircraft carriers. It’s the cleanest, most efficient form of alternative energy. We’ve been saying this since the birth of the Orphans. Fossil fuel is imperative to help us get to the future of energy.

We are not warmongers, but the recent news around China and defense shows that irrespective of politics, most Americans agree on those policies. In addition, the US provides aide to the Ukraine who in turn buys US weapons for their defense. Lastly, we don’t smoke and rarely drink, but the costs on our society of alcohol and tobacco are LESS than that of T2 diabetes and obesity enabled by Coke and Pepsi, two darlings of ESG funds. We have separated politics from a shrewd investment into high expected return securities in the ESG Orphans.

We continue to favor stewarding investor funds towards these smart risk-adjusted return scenario securities as part of a diversified portfolio strategy. This is the ESG Orphans.

Please don’t hesitate to reach out and discuss the benefits of portfolio diversification for the long term and the positive attributes the ESG Orphans can contribute in this manner.

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