There are two elements/risks to ESG investing and both are highlighted in articles in today's daily report. The first is a reminder that returns matter and this is a reference to the very high multiples that are being applied to some of the more speculative clean energy stocks where there is credit being given today for technology and scale tomorrow. As with the tech bubble, there will inevitably be companies that fail, either because they have an offering that either will not work or will not be economic or because the market moves away from what they are doing. The fuel cell stocks would be at risk if hydrogen remains too expensive to consider as a transport fuel and if batteries or bio-based fuels become the dominant solution. Equally, bio-fuels could fall out of favor if hydrogen is abundant. On the polymer side, better collection and more chemical recycling could make switching to biodegradable polymers unnecessary or uneconomic. There will be winners and losers on this basis and the better strategy is to buy baskets of new technologies rather than bet on just one.
The other major ESG investing consideration is identifying what will get excluded and divesting ahead of time. The headline that New York will review its oil holding is a reminder that this is an evolving process and it is getting harder to justify owning fossil fuels in many portfolios today. What happens to any stock or sector depends on what the marginal investor is doing and if the marginal investor in conventional energy is selling then the relative underperformance is almost assured. What will create a floor will either be a compelling dividend yield – in the case of energy likely very compelling – or valuations that drive M&A and associated synergy-driven gains in earnings. Still, the pool of income-based investors and event-driven investors that do not have an ESG overlay is shrinking.