Recent years, green equities have gained traction among investors seeking to align their portfolios with sustainable practices while targeting strong returns. However, their performance during market volatility, especially in weak equity markets, highlights certain challenges. Research by FTSE Russell examines how green equities often underperform in the short term, primarily due to their higher beta, growth-oriented nature, and lower yields compared to the broader market. Despite this, the study also reveals the long-term resilience of green equities. Over time, these investments have outpaced broader equity markets, driven by the global shift toward sustainability and innovation in green sectors. FTSE Russell’s research suggests that while green equities may face short-term setbacks during downturns, they tend to recover strongly and show strong long-term growth potential. This dynamic offers valuable insights for investors seeking to balance short-term risk with long-term sustainability and profitability in their portfolios.
The Performance of Green Equities in 2022
The year 2022 was a challenging one for global equities, as inflationary pressures, rising interest rates, and global geopolitical uncertainties contributed to a market downturn. According to FTSE Russell, the FTSE All World Index, a broad representation of global equities, closed down by 17.7% in 2022. This marked a tough period for investors, who saw widespread losses across various sectors. For green equities, however, the performance was notably weaker, mirroring broader market trends. FTSE Russell’s research indicates that green equities underperformed in this period, with factors like higher beta, greater growth exposure, and a lower yield compared to the broader market contributing to their struggle.
The report from FTSE Russell explains that in weak equity markets, green equities, by nature, tend to underperform. This underperformance is tied to their structure, which typically includes more growth-oriented companies that are more volatile and sensitive to macroeconomic pressures. Furthermore, the report notes that green equities often present a lower dividend yield, making them less attractive in environments where investors are focused on defensive, income-generating assets.
The Nature of Green Equities and Their Sector Exposure
Green equities are generally tied to the environmental and sustainable sectors, which encompass industries like renewable energy, energy efficiency, sustainable agriculture, and green technology. The FTSE Environmental Opportunities All Share Index (EOASI) is an index designed to capture the performance of companies involved in these sectors. It tracks firms with at least 20% of their revenue derived from green-related activities, as defined by the FTSE Global All Cap Index. The EOASI has been running since 2008 and serves as an indicator of the green economy’s evolution.
One of the most interesting takeaways from FTSE Russell’s research is how green equities’ performance varies across different time frames. While green equities tend to underperform during periods of market downturns, they show remarkable resilience and recovery in the aftermath of these periods. The FTSE Russell report notes that in all but one of the seven instances when the EOASI fell by more than 15% since 2000, the index outperformed the broader market in the six months following the downturn. This pattern suggests that while green equities may face short-term volatility, they are often poised for strong recoveries and long-term growth once market conditions stabilize.
Long-Term Outperformance of Green Equities
The most encouraging aspect of FTSE Russell’s research is the long-term outperformance of the green economy. From the inception of the EOASI in January 2008 to the end of June 2023, the index outperformed the FTSE Global All Cap Index by a remarkable 76%, on a US dollar total return basis. This data underscores the potential of green equities as a long-term investment strategy. The green economy, driven by innovation, sustainability goals, and shifting consumer preferences, has outpaced broader equity markets, making it an attractive option for those looking for long-term capital appreciation.
Moreover, the EOASI has been the best performer among all FTSE Russell’s key sustainable investment equity indices over the past five years. This performance has been largely driven by the increasing global emphasis on sustainable development, corporate responsibility, and environmental stewardship. As governments around the world ramp up their efforts to tackle climate change, industries tied to renewable energy, sustainable agriculture, and energy efficiency are expected to see continued growth, making green equities a central piece of future investment portfolios.
Volatility and Concentration in Green Equities
While the long-term outlook for green equities appears promising, FTSE Russell’s research also highlights important considerations for investors. One key factor is the volatility of the green economy. Compared to broader equity indices, the EOASI tends to be more concentrated in specific industries, which can contribute to higher levels of risk. The report emphasizes that this concentration, while beneficial in terms of potential returns, also leads to higher volatility and tracking error. For example, industries such as renewable energy, electric vehicles, and clean technology tend to dominate the EOASI, exposing investors to risks associated with changes in government policy, technological advancements, and global supply chains.
Investors must be aware of these risks and ensure they have a diversified approach to investing in green equities. A portfolio concentrated solely on green companies may experience larger swings in value, especially if the market experiences disruptions in the sectors where these companies operate. Diversification can help mitigate these risks while still allowing investors to gain exposure to the growing green economy.
The Green Economy’s Subsector Indices
FTSE Russell’s report also delves into the different subsectors within the green economy, providing a more granular view of how these areas have performed during periods of market volatility. The largest subsector index within the FTSE Environmental Opportunities All Share Index is the FTSE Energy Efficiency Index, which includes companies focused on reducing energy consumption through technology, infrastructure, and innovation. This subsector has significant exposure to cyclical industries such as technology, automotive, housing, and industrials.
In 2022, the FTSE Energy Efficiency Index was among the weakest performers, reflecting broader economic slowdowns and increased costs in these sectors. However, the index saw a strong recovery in the first half of 2023, driven by a rebound in demand for energy-efficient solutions and technologies. This highlights the cyclical nature of green equities, which are often closely tied to macroeconomic factors but can quickly recover when those factors improve.
Frequently Asked Questions
What are green equities?
Green equities are stocks in companies that focus on sustainable and environmentally-friendly practices, such as renewable energy and energy efficiency.
Why do green equities underperform in weak markets?
Green equities often underperform in weak markets due to their higher volatility, growth focus, and lower dividend yields compared to broader market indices.
How do green equities perform in the long term?
Over the long term, green equities have outperformed broader equity markets, driven by global sustainability trends and growing demand for green technologies.
How can I invest in green equities?
You can invest in green equities through green-focused exchange-traded funds (ETFs), mutual funds, or by purchasing individual shares in companies committed to environmental sustainability.
Are green equities suitable for short-term investments?
Green equities are generally more suited for long-term investments due to their growth potential, as they can be volatile in the short term, especially during market downturns.
What sectors are included in green equities?
Green equities are typically found in sectors like renewable energy, clean technology, sustainable agriculture, and energy efficiency, focusing on industries that contribute to environmental sustainability.
Are green equities riskier than other stocks?
Yes, green equities tend to be riskier due to their sector concentration and sensitivity to market conditions, technological advancements, and regulatory changes.
How do I mitigate risk when investing in green equities?
Diversifying your portfolio with a mix of green equities and other asset classes can help manage risk, along with staying informed on industry developments and policy changes.
Can green equities be part of a diversified portfolio?
Yes, green equities can be a valuable addition to a diversified portfolio, offering exposure to the growing green economy while balancing other investments for risk management.
Do green equities offer dividends?
Green equities typically have lower dividend yields compared to broader market indices, as many green companies focus on reinvesting profits for growth and sustainability initiatives.
Conclusion
Green equities present a complex but rewarding investment opportunity. While they may underperform during weak equity markets, particularly due to their growth-oriented nature and sectoral concentration, the long-term growth potential of the green economy is undeniable. The research from FTSE Russell demonstrates that, despite short-term volatility, green equities have outperformed broader equity markets over time, making them a valuable asset class for those looking to invest in a sustainable future.
