January saw a massive reversion of the previous years’ ESG reversion. Everything that got killed in 2022 like tech, ESG strategies, and the SPX screamed higher. 2022’s outperformers like ESG Orphans and energy and value lagged. Stay the course, ESG Orphans will work on longer time horizons.
Monthly Report
January went gangbusters for all the stuff that was most hated on and underperformed last year. The stocks that were the biggest losers, whether the most heavily shorted or the biggest tax-loss selling candidates, or both, led the way in January. Consider these names: AMZN lost 50% in 2022 and gained over 20% in January. AAPL lost around 27% in 2022 and gained over 10% in January. We have talked continuously about how these two are heavily featured in ESG funds, despite hardly being ESG-worthy in the overall context and charade that is ESG.
Looking more broadly, the SPX Index lost 20% in 2022 and gained over 6% in January. In our more direct comparison world, the MSCI ESG Aware Index gained over 6% in January after losing over 22% in 2022. Their similar PnL paths underscore our thesis that everyone is piled into the same names and these indices are nearly indistinguishable when discussing the market and ESG. Everyone knows how tech-concentrated the NDX Index is with those same top 5 tech, these numbers should not surprise for the NDX: Down over 30% in 2022 and up more than 10% in January.
Flows were very ESG reminiscent in January. This was the new money for a new year. This is reflected in the underperformance of our ESG Orphans. It highlights the isolation of the factor and the “anti-ESG” bias. The ESG Orphans were basically flat in January. So, what happened? There was a massive factor reversal. The New Year money inflows repeated the mantra of the past few years. ESG inflows into the biggest and “safest” names, the favorites of the ESG story. This means conversely that moneys were not invested in the ESG Orphans. We also noted several value indices underperformed the broader market.
Again, more evidence that “growth” was sought after, favored while “value” was not. This is the mirror of what happened in 2022 as discussed. I term this to be a correction in the ESG reversion we foresaw last year. 2022 was dominated by the ESG Orphans relative to so many things. The ESG Orphans Index outperformed the SPX by 40% and the NDX by 50%. January saw a correction of that stark ESG Orphans’ outperformance. That said, it rings true to our underlying thesis that the reality of “Truth in ESG” will take longer as firms like Blackrock continue to dig in their heels on ESG and try and redefine it, call it “Sustainable Investing,” and use further political cudgel to reestablish their foothold. But investors who suffered last year will likely suffer again in due time.
Sector Analysis
Let’s look at some of the individual components of the ESG Orphans and dissect performance a little further.
Energy lagged in January using XLE -1% as a proxy. More to the theme here, energy was the biggest outperformer in 2022. It makes sense that the reversion-filled January saw energy lag. For our Orphans, gains in Exxon Mobil-XOM (8% weight) were offset by losses in Conoco Philips-COP (2.74% weight) and Chevron-CVX (6% weight.) The specter of recession or at least weaker overall demand in the economy saw oil lose a little over 1%.
The nuclear energy Orphans were heavy too. Again, not to beat a dead horse, but the XLU as our proxy was around unchanged in 2022 which was a big outperformance versus the SPX Index. It lost 2% in January. Our biggest nuclear orphan is Nexterra-NEE at 5.7% weight, and it lost more than 10% in January. This cost the ESG Orphans over 50bps. That’s a big loss to contend with. There were mild gains
in Duke-DUK (2.8% weight,) but others like Dominion-D (1.8% weight) and Southern Company-SO (2.45%) had small losses.
The weapons’ component of the ESG Orphans (21%) had a strong January relative to other sectors in the group, gaining around 2.8%. This was an interesting outperformer in the basket despite having a strong 2022 gaining over 13%. It still lagged the SPX. The big winner in the Orphans’ weapons component was Boeing (4.6% weight) which gained 13%. Northrop Grumman (2.7% weight) weighed down the Orphans losing 18% and General Dynamics (2.3% weight) lost nearly 8%. Lockheed Martin (5.49% weight) lost around 6%.
Tobacco was mixed in January as well as British American Tobacco (3.5% weight) lost 3% alongside Altria (3.5% weight) losing 2% while Philip Morris (6.6% weighting) gained 3%.
The alcohol space was a mixed bag to start the year with Diageo-DEO (3.9% weight) losing 19bps while Anheuser Bush Inbev-BUD (4.1% weight) gained 38bps and Constellation Brands-STZ (1.33% weight) gained 79bps.
Stay the Course
Our thesis remains intact. Relative to the rest of the market, nobody owns these ESG Orphans. The action seen to end 2022 and then to begin 2023 shows two sides of the same ESG coin. Everyone sells with reckless abandon what they own too much of, the ESG darlings like big tech. We saw this for much of 2022, especially in the final month when the SPX and ESG Indices lost around 6% and the NDX lost over 9%. Then everyone ran to the other side of the ship and chasing everything they just sold, exacerbated by new moneys flowing in under the guise of ESG and chasing those very same names. And that was January’s return compared to the 2022 bearish tilt.
The ESG Orphans remain under owned. They remain uncrowded. They remain quite uncorrelated to most things. They have a defensive and value-based nature to them. Yes, they are going to lag if we are in the go-go era that we saw of the past decade. But the minute the cattle get spooked, in 2022 that was due to the rates’ paradigm shift, there’s a stampede. We saw that in spades in 2022. That was where the ESG Orphans dominated returns.
If the market returns to, “Number go up,” and “Don’t think, just buy,” mentality, all things will go up and the ESG Orphans will lag. But prudent investors realize the high expected return nature of this basket and the superior risk adjusted returns they should provide over time. This is a longer time horizon investment thesis. The bubble that blew from 2009 to 2021 was a 12-year event. The first year of the bubble bursting, last year, was a dramatic one. Most everyone got torched last year, except for those long the ESG Orphans.
The ESG Orphans remain a great addition to a portfolio in providing a barbell strategy and portfolio balance. Each portfolio should have an allocation of these Orphans which provide diversification, decent dividends, lower beta, high quality names, decent cash flows, and a relatively cheaper fundamental profile versus a lot of what is out there and very crowded.
Please let us know if you would like to have a conversation to understand further the attributes of the ESG Orphans and how they may align with investment objectives and provide a great risk/reward balance in your portfolio construction. Our thousands of hours of deep-dive research and investigation
supports the thesis. Several industry legends and luminaries in academia have opined in favor of our stance.
Thank you for your interest and support.
For further information please visit our websites: For ETF information, www.constrainedcapitaletfs.com and for Index information, www.esgorphans.com.
Follow us on Twitter: @ESGOrphan and @MarkNeuman18.
Connect with us via email at: mark@constrainedcapital.com.
Thanks again,
Mark Neuman, Founder/CIO of Constrained Capital
