If you strip out the demand for ESG funds – considerable though it is – the same sectors and assets would still be prominent. Going back four years, to June 2017, the same conventional ETF holds Apple, Microsoft, Amazon, and Facebook as its top four holdings. Add up the two share classes for Alphabet, and it, too, easily makes it into the top five.
Facebook is not spearheading a drive to sustainable agriculture, even if Mark Zuckerberg looks like he has been hewn from a length of quorn; Amazon is not developing eco-friendly cities, unless your definition of this relies heavily on Elysium and you have a highly optimistic view of Jeff Bezos’ orbital ambitions.
That does not mean they are bad businesses, it is just that is not what they are for.
Many of the largest ethical funds provide portfolios of assets that have positive ESG scores, not least through low greenhouse gas emissions. That is fine as an investment strategy, and investors have many reasons to be satisfied with the results.
To be clear: I am not criticising this as an investment approach, but highlighting that its popularity does not constitute a generalised ESG bubble. Many stocks that make it through ESG screens may be richly valued (hardly an anomaly in 2021), but that is not the same thing.
Supply, meet demand
It seems wide of the mark to see this as an ESG bubble when there is still a shortfall of capital to many areas that are crucial to the transition to a sustainable economy. That could be because certain relevant technologies are in their infancy, and therefore too high a risk for many investors (some important areas are essentially venture capital plays, for example), lack of relevant investment vehicles (possibly indicated by the low level of ESG bond fund launches), or insufficient investor information about key areas.
Should investors worry about the valuations of certain stocks and sectors? That would seem prudent. Does this mean that there is a specific ESG bubble? I do not think that case has been made. Indeed, unless you are of the opinion that global warming is a bizarre conspiracy, or an Excel error to dwarf anything done by Rogoff and Reinhardt, it is underfunded. By a long chalk.
The challenge is to connect supply with demand in a way that will help meet sustainability targets and which satisfies investors’ risk profiles and diversification needs.
Dewi John is head of research, UK & Ireland, at Refinitiv Lipper