United StatesThere is an old soccer saying, “Ten men won the league”, that is invoked when a team defies the odds and wins despite being one player short. There are parallels with managing the Impax International Sustainable Economy Fund. Energy, one of the 11 GICS sectors, is excluded from the Fund’s investment universe due to its negative environmental externalities.
This raises the fundamental question: how does this exclusion impact our objective to maintain a low-tracking-error portfolio? In other words, can we still ‘win the league’ by tracking the benchmark without a full team’?
A small, volatile sector
Taking a step back, it is important to understand the role of the Energy sector within the broader market.
As shown in Figure 1 (below), Energy has accounted for only 4% of the Developed ex-US market by value over the past five years, on average. It has also contributed to an even lower share of overall market volatility – 3.6% of the Developed ex-US market volatility has been driven by Energy stocks over the same period.
Significantly, the Energy sector has also exhibited higher return volatility than the broader market. Even though its average monthly return has been broadly in line with that of the market, its fat-tailed return distribution suggests that excess upside events may be accompanied by disproportionately larger drawdowns.
Figure 1: Percentage contribution of each GICS Sector to the annualized volatility of the MSCI EAFE Index, using daily index weights and returns for the period from April 1, 2014 to February 28, 2026. The figure also shows the index’s average sector weight over the same period. Returns are expressed in USD terms.
… but is it an essential one?
The key question is whether, in the absence of Energy sector exposure, the Impax International Sustainable Economy Fund can meet its tracking error objective of 2.5% to 3%.
The answer is, historically, it has. Figure 2 (below) shows that the tracking error contribution from excluding Energy stocks has been moderate – only 19% of the Fund’s ex-post tracking error – over the past five years.
Figure 2: Percentage contribution of each GICS Sector to the ex-post tracking error of the Impax International Sustainable Economy Fund vs the MSCI EAFE Index, using daily constituent weights and returns for the period from April 1, 2014 to February 28, 2026. Returns are expressed in USD terms.
Our analysis further shows that the Fund has performed in line with its benchmark (the MSCI EAFE Index) during ‘energy shocks’, defined as periods when the Energy sector outperformed the broad market by more than 5% (see Figure 3, below). Notably, the Fund performed in line with its benchmark in the first half of 2022, when the Developed ex-US Energy Sector was up by around 10%, as the negative effect of the Energy underweight was offset by particularly strong stock selection and positive sector tilts.
Source: Bloomberg, Impax Asset Management.
Figure 3: Monthly returns of the Impax International Sustainable Economy (‘ISE’) Fund in excess of the MSCI EAFE Index (blue line) and of the MSCI EAFE Energy Index in excess of the MSCI EAFE Index (green line). Returns are expressed in USD terms.
An exclusion that has not derailed performance
Choosing to exclude Energy stocks aligns with our objective to invest in companies contributing to the transition to a more sustainable economy, and also avoids exposure to one of the most volatile corners of the market.
The Energy sector’s relatively small market weight, coupled with our rules-based process, has allowed us to implement this exclusion while still achieving our low-tracking-error objective.
Important Information:
Impax Asset Management LLC is investment adviser to Impax Funds.
Impax funds are distributed by Foreside Financial Services, LLC. Foreside Financial Services, LLC is not affiliated with Impax Asset Management LLC.
You should always consider Impax funds’ investment objectives, risks, and charges and expenses carefully before investing. For this and other important information, please obtain a fund prospectus by calling 800.767.1729 or visiting www.impaxam.com. Please read the prospectus carefully before investing.
Holdings are subject to change.
Risks
Investments involve risk, including potential loss of principal.
Equity investments are subject to market fluctuations, the fund’s share price can fall because of weakness in the broad market, a particular industry, or specific holdings.
Emerging market and international investments involve risk of capital loss from unfavorable fluctuations in currency values, differences in generally accepted accounting principles, economic or political instability in other nations or increased volatility and lower trading volume.
The Fund is actively managed. The investment techniques and decisions of the investment adviser and the Fund’s portfolio manager(s), including the investment adviser’s assessment of a company’s ESG (Environmental, Social and Governance) profile when selecting investments for the Fund, may not produce the desired results and may adversely impact the Fund’s performance, including relative to other Funds that do not consider ESG factors or come to different conclusions regarding such factors.
About the Indexes
The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US and Canada. The MSCI EAFE Index consists of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom. Performance for the MSCI EAFE Index is shown “net”, which includes dividend reinvestments after deduction of foreign withholding tax.
The MSCI EAFE ESG Leaders Index is designed to measure the performance of equity securities of issuers of developed countries around the world excluding the US and Canada that have high Environmental, Social and Governance (ESG) ratings relative to their sector and industry peers, as rated by MSCI ESG Research annually.
Effective March 31, 2021 the MSCI EAFE (Net) Index replaced the MSCI EAFE ESG Leaders (Net) Index as the primary benchmark for the International Sustainable Economy Fund because the Adviser believes the MSCI EAFE (Net) Index is a more appropriate broad-based securities market index representing the universe of securities in which the Fund may invest.
One cannot invest directly in an index.