As published on hedgeweek.com, Thursday February 27, 2020.
The surge in appetite for ESG-themed trades could be leading investors to ignore investment fundamentals – potentially fuelling a ‘90s-style tech bubble, RWC Partners has warned.
The increase in awareness of climate change has prompted allocators to pile into ESG-positive names in recent years, sending share prices soaring, while certain stocks seen as non-ESG friendly – such as tobacco – have tumbled.
But Graham Clapp, portfolio manager of the RWC Continental European Equity Fund, believes the push towards ESG may create bubbles similar to the tech boom of the late 1990s. By the time the tech bubble eventually burst in the 2002 dot-com crash, the stock market almost half its value.
Clapp suggested share price movements increasingly hinge on companies’ ability to address climate change - with investors ignoring fundamentals in search of long-term winners who can better tackle environmental problems.
“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 2000s,” he said.
The veteran stock-picker, who began his investment management career at Fidelity in 1984, established the long/short equity hedge fund Pensato Capital in 2008. Pensato was later acquired by RWC, the London-headquartered active asset management firm, in 2017.
The highly-regarded fund manager, who has typically traded consumer stocks, industrials and technology long and short, said markets are being driven theme-investing, with investors buying companies “just because they have an ESG angle” and “regardless of whether or not they’re actually executing very well.”
He 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.”
He added: “We’ve had multiple profit warnings from the largest manufacturer of offshore wind turbines globally yet this is not being reflected in the share price. Whilst we may see a short-term drop immediately following a warning, this very quickly rallies back and then moves higher, despite the stock looking quite expensive.”
He said people are focusing predominantly on the longer-term potential for wind turbine generation, rather than on the fundamentals of companies themselves.
“The long-term potential for ESG is very strong. But some investors seem prepared to ignore bad execution in the short term,” he said.
He continued: “You can liken it to the tech bubble where people wanted to have exposure to the new economy stocks, so a lot of money poured into certain kind of business models and valuations were pumped up and incredibly stretched. 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 per cent in six months, despite the fundamentals not having changed.”