Is ESG themed investing creating over-valued bubble?

15 March 2020

The ESG sector could echo the tech bubble of the late nineties, as increasing numbers of investors ignore fundamentals in favour of finding long-term winners which can tackle environmental problems, according to RWC.

Graham Clapp, manager of the RWC Continental European Equity fund, said the growing focus on ESG investing is having a more significant impact on the stock market, with some share prices of businesses moving depending on their ability to tackle issues such as climate change. Conversely, sectors such as tobacco have witnessed a clear derating as flows are directed towards ESG-positive stocks.

Clapp said: “We are big believers in ESG investing for the long-term and consider this an important part of our investment process, but that doesn’t mean you can ignore fundamentals in the short-term.

“We have seen numerous examples where markets are being driven by theme investing; buying companies just because they have an ESG angle, regardless of whether or not they’re actually executing very well. The long-term potential for ESG is very strong, but some investors seem prepared to ignore bad execution in the short term.”

This mentality could result in the ESG sector potentially creating bubbles similar to those seen during the tech boom of the nineties when large volumes of money were invested into certain kinds of business models, causing valuations to inflate and become incredibly stretched, Clapp warned.

He added: “When such large influxes occur, as we’re currently seeing with ESG, then supply and demand means the price is going to change. Back in the late 90s a lot of these tech stocks went from 20x to 80x earnings, before subsequently falling back to 30x.

“We’re not quite there yet but it’s getting to the point where anything related to hydrogen or other green technologies, for example, are all up 100% in six months, despite the fundamentals not having changed. Clearly some of these businesses may well be the future, but what we are saying is investors must look at the fundamentals, or else they may suffer the same fate as investors in the early 2000’s.”

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