Stockholm (HedgeNordic) – Fund managers and investors are increasingly integrating environmental, social, and governance (ESG) factors into their investment processes and decision-making. The increased focus on ESG issues, however, is pushing the share prices of ESG-focused companies higher without the consideration of short-term fundamentals, argues RWC Partners’ Graham Clapp (pictured).

ESG factors have been an increasing focus for investors in recent years, as clear signs of accelerating climate change create the need to change human behaviour.  Clapp reckons that the increasing focus on ESG is having a more significant impact on the stock market, with the share prices of some businesses moving on the “perceived ability” to tackle issues such as climate change. Investors are ignoring fundamentals in the hope of finding the long-term winners that can address environmental issues, argues Clapp, who adds that this behaviour shows a resemblance to the tech bubble of the late nineties.

Whereas the team at London-based investment manager RWC Partners “are big believers in ESG investing for the long-term and consider this an important part of our investment process,” according to Clapp, “that doesn’t mean you can ignore fundamentals in the short-term.” He points out that “we have seen numerous examples where markets are being driven by theme investing – buying companies just because they have an ESG angle, regardless of whether or not they’re actually executing very well.”

Clapp puts forward the example of a large manufacturer of offshore wind turbines that had issued multiple profit warnings, yet these warnings are not 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,” highlights Clapp, portfolio manager of the RWC Continental European Equity fund. He reckons that investors are mostly focusing on the long-term potential for wind turbine generation instead of focusing on the fundamentals of the company itself. “The long-term potential for ESG is very strong. But some investors seem prepared to ignore bad execution in the short term.”

These trends can create bubbles similar to those seen during the tech boom in the late 1990s, warns Clapp. “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,” he argues. “When such large influxes occur – as we’re currently seeing with ESG – then supply and demand means the price is going to change.”

The price-to-earnings multiples of a lot of tech stocks went from 20 to 80 in the late 1990s before falling back to 30, points out Clapp. “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 percent in six months, despite the fundamentals not having changed.” Clapp emphasizes that “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 2000’s.”

Picture courtesy of RWC Partners