DESPITE the carbon-intensive energy sector's streak as the best-performing global equity sector in 2021, stocks with their environmental, social and governance (ESG) bases covered have outperformed their non-ESG equivalents in the year, an analysis has found.

In a report on Thursday (Feb 10), investment research company Morningstar said that 66 out of 116, or 57 per cent, of the ESG indexes that it tracks had elicited better returns than their less sustainable counterparts.

The result was even better when viewed through a longer-term lens, as 80 per cent - 88 of 110 - of its ESG indexes with 5-year histories outperformed.

Among this basket of ESG indexes, 97, or 88 per cent, lost less than their broad market equivalents during down markets as measured by the downside capture ratio, the report went on to state.

Within Asia, stocks with 5-year histories tracked under the ESG indexes that did better include Taiwan Semiconductor Manufacturing (TSMC), whose shares had jumped more than 200 per cent in the past 5 years.

Also seen as notable contributors were Hong Kong Exchanges and Clearing, Hyundai Mobis, Infosys, Sony, Daikin Industries, Tokyo Electron, as well as Tencent, although the Chinese tech giant contributed to a drag on the ESG indexes' returns in 2021. In 2020, 75 per cent of Morningstar's ESG indexes outperformed its non-ESG counterparts.

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Commenting on the ESG indexes' performance, Dan Lefkovitz, strategist of the Morningstar Indexes, said sector tilts, security selection and other factors like geographic allocation and yield-curve positioning helped in making sense of the seemingly "mixed" results in 2021.

Technology, which represents a much larger chunk of the market especially in the United States, had performed well over the course of last year, lifting many ESG indexes, he said.

Meanwhile, Lefkovitz attributed the poorer year-on-year performance of ESG indexes in part to surging oil prices, which contributed to energy becoming the best-performing global equity sector. From a sector perspective, 20 of the 22 Morningstar Sustainability Indexes last year were "overweight technology and underweight energy", he noted.

On a closer look, he said that in the first quarter of 2021 when technology lagged, just 24 per cent of Morningstar's ESG indexes beat their equivalents. Within the technology sector, ESG indexes benefited from exposure to companies such as Microsoft, Nvidia, ASML, TSMC, and Infosys, he added.

Lefkovitz, however, concluded that the superior downside protection provided by the ESG indexes assessed in the report supports the view that ESG risks are financially material and the ESG risk rating by Sustainalytics, which Morningstar relied on, helps mitigate risk.

"For sustainability-focused investors, the results are encouraging. Risk attributes tend to be more stable over time than relative returns," he said.

"Lower-volatility investments have also historically been easier for investors to use - less susceptible to dramatic swings that tempt investors during good times and scare them away in bad times."

While Lefkovitz said the experiences of 2021 demonstrate that ESG investments will underperform in some markets and outperform in others, risks and returns of Morningstar's ESG indexes can "certainly be described as competitive".