The green economy in turbulent waters?

By William Nicolle, Analyst, Sustainable Investment Research, FTSE Russell

Equity markets are experiencing a challenging 2022, with the FTSE All-World’s total return down 12.4% since the beginning of the year.[1] While public commentary is focusing on the outsized role of technology stocks in dragging down indices, a parallel but lesser told story is the recent market performance of the green economy.[2]

As explained in our new paper, while green equities substantially outperformed the market since 2003, the current wave of equity market turbulence is hitting them hard – but it’s unclear if this short-term correction will derail the green economy’s longer-term trend of performance, growth and industry disruption.

Figure 1 shows that ‘green economy’ indices – such as the FTSE Environmental Opportunities All Share (‘EOAS’) and the FTSE Environmental Technologies 100, which track companies who derive over 20% and 50% of their revenues from green products and services – saw stronger growth in 2020 and 2021 than the wider equity market (including the oil and gas sector, which recorded negative returns). However, come 2022 green equities began lagging global equity markets, with total returns from greenest indices falling the fastest, whilst there was a reversal in oil and gas’ negative returns since 2020.

So, why are green equities selling off faster than the market? While it is difficult to say for certain, we attribute it to two main reasons. First, after a long period of strong performance, green equities are recovering from extended valuation premiums. The impact of this market exuberance is acting as a headwind on performance for most growth stocks, but it is already unwinding for green equities, with the green economy’s P/E valuation premium over the broader market narrowing substantially in 2021 from a high at the end of 2020.[3] The result: as the market falls, green equities are falling harder, with the greenest equities tending to fall the hardest.

Second, this is also a story about the mixed performance of underlying green sectors such as renewables and low carbon transport, with some laggards acting as a drag on the whole green economy’s growth. While it is typically assumed that renewables dominate the green economy, since the end of 2020 they generated lower returns than the broader environmental markets, with the sector’s performance falling earlier than the broader green economy – 21.2% behind the EOAS in 2021. Over the same period, other green sectors saw significant growth, such as those related to energy efficiency and water technology, comprising companies like Infineon Technologies, ABB and Xylem Inc.

Despite the short term turbulence, adopting a longer-term view tells the story of the green economy’s strong long-run performance (Figure 2). Over the last five years, the FTSE Environmental Opportunities All Share index outperformed the wider equity market by 5.9%, and the oil and gas sector by 19.8%.[4] It also shows that the structural trend of the growing green economy has weathered periods of underperformance in the past – in 2008, 2011 and 2018 – each time bouncing back stronger than it was before.

The long-term drivers of this fast-moving market are still gathering momentum; government focus on climate finance, investors’ interest in sustainable investment, growing solutions to resource and pollution challenges,  and the disruption of industries like autos, power generation and materials with new, green technologies. The new geopolitical focus on energy security could also be positive for green companies, with renewable generation and energy efficiency forming a central part of the Europe’s energy independence plans.[5]

While predicting the on-going impact of geo-political risk and the broader market transition on the green economy is difficult, current market turbulence highlights the importance of investors distinguishing between short-term swings in green equities and trends in the broader green economy.

Read the paper in full. For more on ESG equity performance, subscribe to the blog 

[1] See FTSE Russell (2022), Factsheet: FTSE All-World Index [data as at 31st May 2022].

[2] Technology stocks are down 21.2% – comparatively larger than the All-World index; See FTSE Russell (2022), Factsheet: FTSE All-World Technology Index [data as at 31st May 2022].

[3] See FTSE Russell (2022), Investing in the Green Economy 2022: Tracking performance and growth in green equities, Figure 22 (‘Market capitalization to net profit ratio’), P24.

[4] Based on the difference between compound annual returns, calculated on a three-year (December 2018 to December 2021) and five-year basis (December 2016 to December 2021); for more details, see FTSE Russell (2022), Investing in the Green Economy 2022: Tracking performance and growth in green equities, P22.

[5] European Commission (2022), REPower EU: affordable, secure and sustainable energy for Europe.

 The FTSE Environmental Opportunities All-Share Index comprises all of the companies that have significant involvement in environmental business activities and meet the environmental opportunities eligibility requirements. and the FTSE Environmental Technology 100 Index Series measures the performance of companies globally whose core business is in the development and deployment of environmental technologies as defined by the FTSE Environmental Markets Classification System (EMCS).  FTSE All-World index series is a stock market index that covers over 3,100 companies in 47 countries, which started in 1986 as the FT-Actuaries World Index. Investors cannot invest directly in an index. 

This post first appeared on June 27th, 2022 on the FTSE Russell blog



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