Investors’ thirst for environmental, social and governance (ESG) investments has been seemingly insatiable in recent years, with $32.1bn (£24.4bn) entering sustainable equity funds last year alone, according to data from Calastone: the equivalent of $3 from every $5 of new money invested across all equity funds.
However, this surge is cause for concern according to David Coombs, multi-asset fund manager at Rathbone investment management, who said that too much money is being funnelled into the sector.
He said: “Its’s a very nascent industry so there will be significant losers in that space. Not everyone is going to make money.”
Coombs has reduced the exposure to obvious ESG winners within his own sustainable funds in the Greenbank range as retail investors flood the market.
A particular sign for alarm, he said, is when passive portfolios from large fund houses begin to add the same holdings as him, at which point he is likely to withdraw his investment.
He added: “Money is being funnelled into this area and everyone is scrambling to make renewable investments. That always makes me nervous because too much money goes in too soon, and it doesn’t always find the most efficient use of capital.”
One market where Coombs says ESG assets are particularly in need of a rethink is in the UK, where there is only a “vague plan” on how the country intends to meet its net zero target by 2050.
While more than 190 countries committed to goals set in the Paris Agreement, the UK has taken more aggressive action, adding an additional target of reducing emissions by 78% by 2035.
Although the mission to tackle climate change is a noble one, Coombs said that the government’s current strategy on how it intends to meet these ambitious targets is unrealistic and is likely to result in higher consumer costs.
He said: “There’s a lack of honesty with the electorate which is coming back to hurt now because people can see the bills hitting their doormats. There is a cost to this. It’s not being paid for by a few rich people – we’re paying for this. All of a sudden it feels quite different.”
Potential economic impacts from the clean energy transition were also mentioned by Karen Ward, chief market strategist of Europe, middle east and Africa (EMEA) at JPMorgan, who said: “We need to really think about the role of that transition and some of the upward pressure that puts on inflation over the medium term.”
The same goes for private companies – more than 21% of the world’s biggest companies set net zero targets last year, but Coombs said that if they don’t have a thorough strategy on how to achieve this, then investors will have to “take those pledges with a pinch of salt because they’re not worth anything”.
Other countries have taken more decisive action on how they intend to transition, such as the US, which has committed to extending its shale extraction operations, while the UK has played with the idea of using heat pumps to recycle warm air.
“It’s alright ticking the box saying I’ll do this, that, and the other by 2050 but if you’ve got no plan to get there it’s hot air – no pun intended.”
Although the US is taking a slower path to net zero, Coombs prefers the region for sustainable investments, stating: “We can’t buy US treasuries in our sustainable funds because the US is seen as being behind the curve on emissions, yet I would argue that it is more realistic.”
This regional preference is reflected in the allocations of the Greenbank Global Sustainability fund which, despite not being directly manged by Coombs, is overweight US with 56.9% stake while the UK is the smallest area holding of 4.3%.
He added: “We think the US is in a better position to manage that position.”
Recent events in Europe have added significant urgency to the clean energy transition, with Western countries seeking new, domestic energy sources to make up for lost imports from Russia.
Andy Merricks, fund manager at 8AM Global, said: “The dependence that much of Europe has to Russian oil and gas has acted as a turbo charge to the alternative energy sector since the invasion of Ukraine.”
There has been debate in the UK as to whether it should temporarily lift some environmental planning hurdles to rapidly build more oil wells in the North Sea or double down on producing more sustainable energy plants and wind farms.
This pressure has been less felt in the US, which is not as reliant on foreign imports than Europe. It is another reason why Coombs finds the region more attractive.
He said: “US companies clearly have access to cheaper energy than European companies from a cost perspective because of US shale. The US is energy independent pretty much.”
Out of the 7.8 million oil barrels exported from the US every day, more than half (4.5 million) go to Europe while just 626,000 arrive in the US.
Coombs said that he’s “very constructive on renewables” and believes the sector has good potential, but fund managers should consider the financial and ESG aims alongside each other before investing.
He said that within in his own funds, “the financial and ESG objective are equally weighted so that we don’t lose sight that actually we’re still investing people’s savings and retirement money here”.
For example, Coombs and his team, like many others were excited by the prospect of investing in vegan companies Oatley and Beyond Meat, but after examining their financials decided not to invest.