As more investors crowd into socially responsible investments, some are warning of a potential bubble forming in the environmental, social, and governance exchange traded fund category.
ESG-related ETFs attracted a record $85 billion across the U.S. and Europe over 2020, and the funds are still raking it in, Bloomberg reports. As more money flowed into these strategies, stocks in many of these funds are now trading at elevated price-to-earnings multiples that are increasingly hard to justify.
“There is a risk that holdings that populate ESG funds have become overvalued,” Chris Dyer, director of global equity at Eaton Vance, told Bloomberg. “Investors – both active and passive – are increasingly chasing these themes and driving valuation to uncomfortable levels in some cases. This type of naïve investing tends to end badly.”
Bank of America strategists warned that clean energy ETF flows are creating potential bubbles in individual stocks like EDP Renovaveis SA, Orsted AS, and Verbund AG. The rally in those European utilities also came as the industry saw a fourfold increase in flows to a related iShares Global Clean Energy ETF that holds these companies.
“While we recognize 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,” BofA strategists, including Peter Bisztyga, said in recent report, adding that the flows have “created a bubble in these three stocks.”
Additionally, BofA strategists are warning that after some caught on to the frothy valuations in the ESG category with short positions to bet on the eventual pullback, the new day trading phenomenon that targets highly shorted companies could also make an appearance in this socially responsible investment segment.
In a recent research note, Bank of America’s analysts showed concern that “ESG darlings” might be affected by “the next leg” of this trend of forcing a short squeeze on specific targets, CNBC reports.
For more news, information, and strategy, visit the ESG Channel.