Environmental, social and governance funds outperformed this year due to their better stock selection process.

According to the World Resources Institute, nine of the 10 largest U.S. ESG-related, large-cap mutual funds and ETFs outperformed the S&P 500 in the first half of 2020, beating the benchmark on average by 2.1 percentage points, the Financial Times reports.

The sustainable development think-tank pointed out that ESG funds’ exposure to information technology, the best performing sector in the first six months, was on average 1.71 percentage points above that of the benchmark. Additionally, their exposure to energy, the worst performing sector, was around 1.33 percentage points less than the S&P 500.

When looking at attribution analysis, or the sources of excess returns, the researchers found that the differences in sector exposure only made up 0.77 percentage points of the ESG funds’ outperformance.

In particular, almost 0.65 percentage points of outperformance was attributed to picking better performing stocks within each sector, according to the analysis. The remaining 68 basis points of outperformance was associated to factors like the “interaction effect” between positive sectors and stock selection, along with well-timed trading.

Superior Stock Selection

All in all, the positive stock selection were best in the financial, healthcare and industrial sectors.

“Surprisingly, the largest ESG funds are doing well on both fronts: asset allocation and stock selection,” Lihuan Zhou, lead author of the analysis, told the Financial Times. “We thought [the stock-selection effect]was very intriguing.”

However, Zhou underscored the lack of clarity in the stock selection process among the various funds, which made it difficult to pinpoint the exact positive impact in the first six months of the year. So, onlookers aren’t able to precisely infer any real insights to replicate this outperformance.

“We didn’t find a very good answer, partly because the fund processes and indexes remain a black box,” Zhou said.

“We can only find limited information on stock selection from public data,” he added. “Investors would benefit from greater transparency [and]published methodologies.”

Linda-Eling Lee, global head of ESG research at MSCI, argued that while granular data on each company is only available to clients and the provider company, the ESG rating system is still openly available.

“I think that we are pretty transparent about the entire process and well as about the methodological components,” Lee told the Financial Times. “I think what is true is [these models]are complex. I feel there is some confusion between complexity and transparency.” MSCI alone runs 1,000 ESG indices across equity and fixed income.