Investor Mary Jane McQuillen was a proponent of ESG even before it had its name.

Two decades ago, she served as one of 12 asset managers who helped former United Nations official Paul Clements-Hunt coin the term for what’s now a $3 trillion fund sector that aims to not only reap financial returns, but also deliver positive impacts on environmental, societal and governance issues.

“We thought the more investors understood what we were doing and the more who adopted this, it could have a global net positive effect — not just for our stocks in terms of performance, but in terms of impact,” said McQuillen, who, along with her UN’s Environment Programme Finance Initiative peers, held meetings and conferences around the world to help integrate ESG into institutional investing.

That was then. In recent years, rancor against the sector by US Republicans and mounting questions around the strategy have put McQuillen and other ESG adherents on defense. Investment giant BlackRock Inc. has faced relentless attacks from conservative politicians over ESG, while some companies such as McDonald’s Corp. are quietly removing ESG language from corporate websites to avoid scrutiny. Others, including Coca-Cola Co., Exxon Mobil Corp. and Volkswagen AG, have been accused of making insincere corporate commitments about environmental and sustainable practices.

At the end of last year, the sector posted its worst quarter in history, with net outflows of more than $5 billion from US-based funds. The average US-based ESG equity fund rose about 19% last year, trailing the 26% gain of the S&P 500, including reinvested dividends, according to data compiled by Bloomberg.

“Now everyone’s like ESG, ESG, ESG. Everyone’s all upset with it,” said McQuillen, who oversees some $2.8 billion in ESG investment strategies, including the ClearBridge Sustainability Leaders Fund.

The ClearBridge fund invests in a basket of the firm’s top-rated ESG stocks, and avoids fossil fuel, controversial weaponry and tobacco-linked investments.

The fund gained roughly 90% over the past five years, outpacing the roughly 76% return on its benchmark, the Russell 3000 Index, during that same period. But more recently, it has trailed the broader market because of headwinds like the rise in commodity prices in 2022, last year’s regional banking crisis and the Federal Reserve’s aggressive interest-rate hiking campaign. Year-to-date, McQuillen’s fund is up 7.6%, compared with a 7.3% increase for the Russell 3000.

Too frequently, McQuillen says, the sector is held to a “different standard” than other active funds.

When critics “single out” actively managed ESG funds, she says it’s important not only to consider the type of fund — whether all-exclusionary, thematic or diversified — but also the time frame in question and performance of its non-ESG actively managed peers.

Often, “mainstream managers didn’t perform either,” McQuillen said pointing to the market weakness of 2022 when the S&P 500 and Nasdaq 100 plunged 19% and 33%, respectively.

“It wasn’t just ESG funds that experienced that,” she said. “It was a very large swath of the buy-side.”

Some critics say that ESG funds can’t outperform their benchmarks because certain companies are left out of the fold. But McQuillen sees this practice as judicious, not exclusionary. Across ClearBridge’s ESG portfolio strategies, McQuillen notes several instances of outperformance dating back to the dot-com bubble in 2000 and the global financial crisis.

“ClearBridge excludes companies with low quality, poor management teams and poor capital allocation,” she said. “But we’re more focused on what we can include and diversification.”

The firm is a long-term owner whose average five-year holding period significantly exceeds the roughly 1.5 year US average. Most ESG funds are predominately large-cap weighted, but McQuillen and her co-portfolio manager Derek Deutsch’s fund takes a different approach as a diversified all-cap blend that values small and mid-cap companies.

McQuillen says she and her partner are keen on small and mid-cap companies because they’re often “pure plays,” dedicated to one specific product.

To be sure, like many ESG funds, ClearBridge holds some of the tech giants. ESG funds have long been scrutinized for relying on Magnificent Seven stocks — a group that’s responsible for more than 40% of this year’s market rally. However, McQuillen says tech’s low carbon footprint is often what’s attractive, noting Microsoft Corp. and Apple Inc.’s commitment to 100% renewable power.

“In the market we’ve had over the last year and a half, when it’s big tech driving indices, you have to have that exposure,” said Todd Sohn, a market strategist at Strategas Securities LLC. “Otherwise, clients are going to get frustrated.”

Microsoft, the fund’s largest holding, represents many of the high quality characteristics that ClearBridge screens for, McQuillen said. The firm has been engaged with Microsoft’s management team on ESG issues since 2004.

ClearBridge sees opportunity in clean energy. A pullback in rates, improving economics and pending policy developments stemming from the Inflation Reduction Act make clean energy more attractive for the long term, McQuillen wrote in her 2024 outlook. She points to Eaton Corp., one of the fund’s holdings, as a beneficiary of the IRA and being well-positioned to support electrification and energy efficiency.

As the world gets closer to net zero and decarbonization, “renewable power isn’t going to solve everything, but it’s an almost straightforward, easier portion” McQuillen said. “The puzzle is pretty big and you’re going to need lots of things, including real world outcomes, and renewable power is just one component of that.”

This article was provided by Bloomberg News.