Weekly Dose of ESG
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Weekly Dose of ESG

Weekly Dose of ESG — ESG: Just another bubble?

ESG: Just another bubble?

Friday, 4th February 2022

Source: ahseeit

What is going on?

January 2022 was a harsh month for the markets. Every major index around the world ended the month in negative territory. In America, the selloff was particularly strong in the highly valued technology and growth stocks. When looking at the major 11 S&P sectors, interestingly only the energy sector was positive for January. Many favourites of sustainable funds suffered while the “environmentally bad” energy sector rose. Comparing the MSCI World and the MSCI World ESG Leaders shows, that the standard index outperformed the ESG leaders in January, a rare event. Considering geopolitical tensions around the world, rising oil and gas prices as well as rising interest rates, are we looking at a bursting ESG bubble and the return of the not so sustainable parts of the market?

What does the data tell us?

Indeed, some indicators are pointing towards an overheated ESG market.

In their Quarterly Report from September 2021, the Bank for International Settlements (BIS) focused on exactly that question. Is sustainable finance overvalued? The BIS compared the current rise in ESG and SRI funds to the development of Mortgage-Backed Securities, the infamous financial instrument that ultimately led to the financial crisis in 2008, at the beginning of the 2000s. The numbers look surprisingly identical. Over six years, the value of both markets rose to around $2 trillion with ESG stocks trading at a significantly higher price-to-earnings ratio than the overall market.

Comparing the performance of MSCI World to the MSCI World Leaders again, it becomes clear, that the ESG Leaders outperformed the global index in pretty much every period over the last 10 years. Our own data provided by S-Ray shows the same. In most years since 2007, the top two quintiles of the screened stocks globally outperformed both the lower quintiles and the overall market.

Additionally, a recently published paper showed, that the main performance driver of sustainable stocks is not the sustainability aspect per se. In fact, it is the price pressure arising from flows towards sustainable funds and stocks. So much, that without the flow driven price-pressure, ESG funds and ETFs would have significantly underperformed the market between 2016 and 2021.

What is the takeaway?

So, is there a bubble and should we stop investing in sustainable funds and stocks? In a short answer, no. Considering global trends such as climate change and decarbonisation as well as changes in our society, we believe that sustainable companies will keep outperforming. And we are not alone with that view, as two-thirds of professional investors believe that ESG is the future. Ultimately it comes down to finding the companies with real ambitions in following a sustainable strategy. One important factor to find these is the standardisation of reporting arrangements and taxonomies, driven by regulators. Another aspect is the transparency of ESG data, something we work on heavily with our ESG Book solution.

See you next week!

Paula & Philipp



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