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Concerns over clean energy bubbles are misplaced

By Saker Nusseibeh
 — 1 minute read

In recent months concerns have grown about responsible investment “bubbles”. In May, MSCI warned that clean energy exchange-traded funds are as crowded as technology stocks were at the height of the 1999 boom.

Saker Nusseibeh

Yet, whether we like it or not, bubbles are exactly what we should expect at this stage of the sustainable economic transition. 

The danger is that we interpret their existence as somehow invalidating responsible investment, rather than as a useful signal to seek more effective ways to create sustainable wealth for investors by improving society and our planet.

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Comparing clean energy with the technology boom in the 1990s is a useful analogy. Both represent a fundamental change in the way society functions.

At the turn of the century, the internet was already changing the way we consume information, providing new ways to communicate and rerouting channels for commercial activity.

In a similar vein, clean energy sources are enabling the essential and inevitable replacement of older carbon-hungry ways of producing power with cleaner sources. Renewable energy has already overtaken fossil fuels as the primary source for UK electricity production. 

As an investment theme, clean energy has proven to be particularly popular, driven by widespread recognition of risks associated with carbon-intensive assets in passive portfolios. This, in turn, has driven demand for exchange-traded funds (ETF) that track clean energy indices to record highs.

These indices are constructed by screening companies for their environmental characteristics, overweighting those with a high score, while excluding those with the lowest score. 

Such an approach initially proved effective, given these factors had not previously received much attention, so indices weighted toward these companies performed well.

But demand has grown so rapidly that the underlying stock prices have been inflated to the extent that MSCI has warned of concentration risk in these products. 

In turn, this has increased the likelihood of a price bubble and the potential for it bursting. If it does, some investors may be left wondering if “responsible investing” has had its day.

Yet such a view is misplaced and akin to saying that long-term investing in the internet would never work out after the dot-com bubble. A decision to exclude tech stocks back in 2000 would have proven particularly punitive for investors over the past 20 years. 

Responsible investing is a far greater, structural evolution in investing than a narrow index-linked fund and one the world is finally waking up to. And consequently so has the rest of our industry.

It is also about much more than environmental concerns. It is an investment approach that, I would argue, ensures asset managers fulfil their fiduciary duty. 

I have long thought that our responsibility to investors goes far beyond examining traditional metrics alone, important though as they are. Relevant and material environmental, social and governance factors are vital to every investment decision. Ignoring them risks missing significant potential risks and growth opportunities associated with a company.

Equally, sustainable wealth creation should not necessarily rest simply on selecting those companies that are strong on ESG.

For example, investment managers can identify companies that need to better manage their environmental risks, improve their governance practices or address their labour practices. All of which have the potential to drive value as they improve, a premise supported by research that has found that 90 per cent of studies on the subject found a link between sound ESG standards and lower cost of capital. 

Asset managers then have the ability – and not enough do –  to engage and support investee companies to enhance their ESG characteristics through what is called stewardship. Regular dialogue with the board or use of voting rights are just two of the approaches asset managers can deploy to help improve firms to the benefit of many stakeholders – investors, employees, customers of the investee firm and, ultimately, society at large.

By investing in this way – through deep fundamental analysis and stewardship –  investors targeting long-term sustainable wealth should be comfortable with their portfolios deviating considerably from index benchmarks. After all, the decision to invest is driven by where the opportunities lie, rather than attempts to mirror an index. This then creates the additional opportunity to sidestep bubbles emerging in the latest thematic responsible investing trend. The best stockpickers, of course, do not follow a crowd.

To my mind, responsible investing is not a bubble ready to burst. It is an economic and societal transition – a revolution even – that is critical to long-term wealth creation for investors and to the health of our planet. 

Saker Nusseibeh, chief executive, Federated Hermes

 

The ifa Excellence Awards are back in 2021 and nominations are now open! This prestigious accolade recognises exceptional professionals within the financial advice industry, shining a light on the outstanding achievements from the nation's best and brightest. If this sounds like you or someone you know, then nominate today for the ifa Excellence Awards 2021!

 

Concerns over clean energy bubbles are misplaced
Saker Nusseibeh
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