It paid for investors to be sustainable in 2021, even as energy companies were among the stock market’s best performers.

Companies that scored the strongest on environmental, social, and governance metrics saw some of the highest returns in 2021 with help from stocks such as Nvidia NVDA, Microsoft MSFT, and TSLA TSLA.

The Morningstar U.S. Sustainability Leaders Index--representing the 50 U.S. companies with the best ESG scores as measured by Sustainalytics (a division of Morningstar)--returned 33.3% for the year, beating the broader U.S. market by more than 8%.

It wasn’t just companies ranked the very highest in ESG scoring that outperformed. Morningstar’s broadest basket of sustainable companies, measured by the 373-stock Morningstar U.S. Sustainability Index, returned 29.1% in 2021, 3 percentage points better than the overall U.S. stock market.

That ESG strategies outperformed in 2021 is notable given the best-performing stocks across the market last year by far were oil and gas focused energy companies--names that don’t make it past ESG screens. Instead, the companies that are the very strongest from an ESG perspective tend to be large- or mega-cap, high-growth, technology companies. In 2021, these areas of the market did especially well--well enough to power past the gains in energy stocks.

“This year, companies with better ESG risk assessments outperformed their peers with the weakest ESG assessments,” says Sara Mahaffy, ESG strategist at RBC Capital Markets.

The outperformance of sustainability strategies was widespread in 2021, based on Morningstar’s data. Within the Morningstar Sustainability Index family (indexes designed to target stocks with low ESG risk ratings), 14 of 21 indexes outperformed over the past year, compared with 18 of 21 outperformers in 2020. Nine out of 10 of the Morningstar Low Carbon Risk indexes beat their benchmarks in 2021.

And in the fourth quarter, the Morningstar Sustainability Dividend Yield Focus Index, a collection of companies with both healthy income streams and strong ESG scores, posted the highest return, modestly outperforming the Morningstar U.S. Sustainability Leaders Index.

With the numbers posted in 2021, sustainable investing strategies continue their run of beating conventional market benchmarks over longer periods. Six out of the 10 U.S. sustainability indexes beat their benchmarks over the trailing three-year performance period, as did seven over the five-year period.

As Jon Hale, head of sustainability research for the Americas at Morningstar, wrote, “Last year's performance adds to the evidence that investments that use environmental, social, and governance ratings and metrics to select securities and structure portfolios can deliver competitive returns.

Under the hood, a number of factors worked in favor of sustainable strategies in 2021.

Lan Anh Tran, associate manager research analyst for passive strategies at Morningstar, notes that individual stock weights were a big part of the story.

"When ESG funds exclude less-sustainable companies, they tend to pile up positions in mega-caps that earn better ESG metrics,” meaning that they have a disproportionately higher representation than the conventional index, says Tran. “Companies like Microsoft and Tesla that pass ESG screens end up carrying nearly 2 times their broader market weight. That has implications on performance.”

In 2021, those weights worked in favor of ESG strategies. Nvidia, a mega-cap tech company that returned over 125% in 2021, has a 3 times greater weight in the Morningstar U.S. Sustainability Leaders Index than in the broader market. It’s a similar story with Microsoft, which gained 52% last year. The software giant constitutes nearly 10% of both the Morningstar U.S. Sustainability Leaders and the standard Morningstar U.S. Sustainability Index, compared with just over 5% of the Morningstar U.S. Market Index.

Another factor is companies that don’t make it past the stricter screens. All of the stocks in the Morningstar U.S. Sustainability Leaders Index have Sustainalytics 4- or 5-Globe Ratings, indicating that each company is managing relevant ESG risks more effectively than industry peers.

Meta Platforms (formerly Facebook) FB and Amazon.com AMZN, for example, can be excluded from ESG portfolios based on assessments of their negative societal impacts or corporate governance risks. Because these stocks are so large, that leaves a gap that tends to get filled by the large-cap ESG heavyweights. “Simple ESG screening strategies are always going to look similar to the broader market,” adds Tran, “but stricter screens can result in stark differences.”

“These differences in weight are notable,” says Tran, “but they’re also a quirk.” One that can either help or hurt the performance of ESG strategies. “If Microsoft took a hit, then ESG would too.”

These individual stock weights help offset some market sector headwinds in 2021, most notably the lack of energy stocks.

ESG screens often avoid the energy sector, an area of the market filled with oil and gas companies. The Morningstar U.S. Sustainability Leaders Index had virtually no exposure to the energy sector last year, and the less-extreme Morningstar U.S. Sustainability Index cuts out half of the energy weight that the Morningstar U.S. Market Index is exposed to.

But even as the Morningstar U.S. Energy index gained 55% in 2021 (the strongest return the sector has seen in more than 10 years), sustainability outperformed the overall market. That’s mainly because the energy sector is just a small part of the overall market, making up less than 3% of the Morningstar U.S. Market Index.

“Yes, energy did well this year” says Tran, “but it makes up a small enough portion of the broader market indexes that it doesn’t make a huge difference for overall performance.”

The tech and consumer cyclical sectors had a more notable impact on sustainability portfolios. Over the past five years, the Morningstar U.S. Technology Index has grown more than 30% and the Morningstar U.S. Consumer Cyclical Index is up 24%, ahead of all other U.S. sector indexes--and both the Morningstar U.S. Sustainability Leaders and Morningstar U.S. Sustainability indexes carry extra concentrations in those two areas.

In 2021, those differences in composition contributed to sustainability stocks’ group outperformance. Though none of the other top contributors saw gains as large as Nvidia's, both Accenture ACN and Home Depot HD rose nearly 60% for the year, with Microsoft close behind at a 52% return.

Among U.S. indexes, the Morningstar Sustainability Dividend Yield Focus Index performed the best in the fourth quarter, recovering from weakness earlier in the year. The index is a group of companies with both healthy dividends and strong management of ESG risk. Gains in the index were led by healthcare company and maker of the first available coronavirus vaccine Pfizer PFE (up 39% for the quarter) and semiconductor producer Broadcom AVGO (up 38%). The index gained 12.7% in the last three months of 2021, followed closely by the Morningstar U.S. Sustainability Leaders Index, which gained 12.5% during the same period. Despite the strong year for sustainability portfolios, 2021 was muted for ESG compared with 2020. Globally and across all markets, 61% of Morningstar’s ESG-screened indexes beat their broad market equivalents in 2021, down slightly from 72% in 2020. Morningstar Direct and Office users can view full quarterly sustainable indexes performance reports here.