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Beware of ESG bubbles

For financial professionals only

As we’ve adapted to the pandemic, we’ve become familiar with support bubbles. But should investors be wary of a bubble forming in ESG investments?

While we’re excited about the potential long-term opportunities, selectivity will be key when navigating the growing ESG landscape.

A growing interest

A recent study by Next Wealth1 found ESG investing comes up in a fifth of client conversations – nearly 3 times more than 2019. On average, ESG investments have grown to 15% of client assets, with 68% of advisers expecting this to increase further.

Signs of investor overconfidence?

However, there have been signs of over-exuberance in some markets recently. The clean energy area has been hugely popular, for example BlackRock’s iShares Global Clean Energy ETF. The charts below show its performance and volatility compared to the broad global market, as measured by the FTSE Developed index, over the last 5 calendar years.

 

 

Source: FE Analytics

Past performance cannot be used as a guide to future returns, investments can rise as well as fall in value and you may get back less money than you invested.

iShares Global Clean Energy ETF returned over 130% in 2020, but investors experienced a bumpy ride as volatility was materially higher than the market.

This has been driven by substantial inflows. From late 2019 to early 2021, assets under management for the overall strategy grew over 1550%, rising from c.£570m to nearly £9.5bn, before dropping over the last few months as performance dipped over 2021 so far.

But will performance recover, or will we see continuing volatility?

Source: FE Analytics

Finding a balance

It’s difficult to know when a trend becomes a bubble, or when a bubble may burst. Rather than trying to predict this, we avoid investing in single-themed funds. In our Ethical solution, we diversify our portfolios across companies with exposure to various themes.

New themes will emerge as ESG becomes increasingly important, and it’s important to be aware of their impact. Technological change in ESG-related areas is evolving rapidly, creating long-term opportunities for leading managers to get ahead of trends and generate attractive risk-adjusted returns.

For example, Liontrust recently added a new “encouraging sustainable leisure” theme within their Sustainable Future portfolios, and Pictet are investing in plant-based meat in their Global Environmental Opportunities strategy.

Ultimately, we can build balanced asset classes and portfolios that achieve repeatable returns, delivered within a consistent risk-controlled manner. Diversification across various layers – be it asset classes, fund managers, ESG themes – should mean more protection as market areas move in and out of favour. We want to give clients the outcome they expect, regardless of their ethical preferences.

1 NextWealth ESG Tracker Study Update, April 2021, nextwealth.co.uk/wp-content/uploads/Nextwealth-ESG-report-April-2021.pdf