Tidal wave” of ESG inflows continues, but returns can’t hold up, warns RWC’s Clapp

European ESG stocks continue to see a “tidal wave” of inflows, but the levels of capital flooding in to certain stocks has far surpassed the fundamental outlook for the stocks, leaving investors’ at risk of losses, according to RWC Partner’s Graham Clapp.

ESG has emerged as one of the winning trends this year, with the theme taking in more and more money. IA statistics released this month revealed responsible investment funds saw total FUM rising by 89 per cent to GBP33 billion from January 2019 to June 2020.

However, Clapp, whose RWC Continental European Equity fund is up 17 per cent since inception in November 2017, said this display of “theme” investing, while understandable, was likely to leave many investors disappointed.

“The E in ESG has a lot of momentum right now, and there’s a huge sum of capital going in to companies seen as winners in this space,” he says.

“Many companies at the heart of this trade are loss-making, and keep warning on profits, yet shares keep rising. The situation may become more extreme from here but investors should be aware that the more detached share prices become on the way up, as we are seeing now, then the more extreme the moves can be on the way down.”

While Clapp is a steadfast champion of ESG and its important role in risk analysis and identifying long-term opportunities, he says it’s vital that investors do not lose sight of fundamentals.

He fears in the current environment, ESG investing is almost uniquely positioned to distort share prices, especially as bigger buyers - such as pension funds - attempt to go greener in their own investment approaches.

“This ESG trend was already in place at the start of the year, but the tidal wave has continued throughout 2020,” he says.

“As with any bubble, these things are great on the way up, but the more we move away from fundamentals, the worse the outcome for investors is in the long-term.”

Clapp warned everything from wind turbine manufacturers and battery makers, to hydrogen companies, are feeding into this trend. As a result, the basics of finance are being overlooked in the hope that these names will be the “next big thing” in years to come.

Clapp himself is looking for opportunities elsewhere in Europe. The fund remains exposed to healthcare and consumer discretionary names, amid the ongoing recovery in Europe.

“We are finding the same degree of opportunity elsewhere, without needing to embrace the valuation excesses that are so apparent in ESG stocks right now.”