It’s reality-check time for environmentally and socially-responsible investment funds.
Exchange-traded funds investing in companies with responsible environmental, social and corporate governance – or ESG – practices lured a record $85bn (€70bn) in the US and Europe in 2020, and are still raking it in.
Pumped up by the flows, stocks in many of these funds are trading at frothy price-to-earnings multiples that are increasingly hard to justify. Take US fuel-cell maker Plug Power, for instance. The unprofitable company’s more than 2,000% rally since early 2020 outpaces even car giant Tesla’s.
“There is a risk that holdings that populate ESG funds have become overvalued,” said Chris Dyer, director of global equity at Eaton Vance. “Investors –both active and passive – are increasingly chasing these themes and driving valuation to uncomfortable levels in some cases. This type of naive investing tends to end badly.”
With the Nasdaq-100 trading near dot.com era high valuations of the early 2000s, the likes of Bank of America are floating warning balloons. And, after astronomical surges in shares of renewables – the poster child of ESG investing – market players, including JPMorgan Chase & Co, are trying to be more selective to avert the risk of a sudden pullback.
Although they’re lumped together, it’s mostly the E – environmental – in ESG that’s drawing investor interest. There’s a lot that can still power the flow into environmental funds. In the US, President Joe Biden has pledged to ramp up green energy investments and infrastructure spending.
In Europe, much of the $2.2trn pandemic stimulus package is tied to environmentally friendly practices.
Amid recovery spending, issuance of green, social and sustainability debt is set to reach $1trn this year.
But the flood of funds is raising red flags. Bank of America said clean energy ETF flows are creating potential bubbles in certain stocks.
“While we recognise that these fund flows may continue to drive share prices higher, valuations are no longer supported by our fundamental framework, and we can no longer advise investors to put fresh capital into them,” Bank of America said, adding that the flows have “created a bubble” in at least three energy stocks.
And while the best-performing equity fund in Europe with more than $1bn in assets last year, BNP Paribas Asset Management’s Energy Transition Fund, gained about 165%, some investors say such rallies can’t last.
Valuation worries may mean some of last year’s high flyers will underperform this year.