Are investors paying too much for ESG stocks?

Mark Leach, partner, James Hambro & Partners (Sponsored), 15/12/2020

Investment managers have moved aggressively away from fossil fuel stocks and into the renewable sector this year, but does switching to obvious low-carbon alternatives present a different threat – valuation risk?

In 2019 we saw a 250 percent increase in assets held in sustainable funds. We expect there to have been around £190 billion flow into sustainable funds in the first three quarters of this year alone, relative to £157 billion last year.

Much of the capital has moved into renewable plays like offshore wind and wind turbines.

Our concern is that this is now a risk as well. If you look at the valuations of companies like wind farm developer Ørsted, for example, they are at over 50 times earnings, relative to Shell on less than 10 times. That is pricing in an awful lot of growth when we expect increased competition from the big oil companies transitioning to renewable energy and potentially driving down returns.

Investment choices

At James Hambro & Partners we put ESG and wealth preservation at the core of our investment strategy. So how can our clients and advisers benefit from the transition to a low-carbon world in 2021?

We take the classic picks and shovels approach. We have looked across the value stack. Rather than take the call as to whether solar or wind will win, or whether to back BP or Ørsted, we take the view that, whatever happens, you need network grids that can deal with variable demand on electricity, as well as variable supply. So we have been looking closely at utility companies because they have a natural monopoly.

Yes, it is a regulated monopoly. But the regulator and the government are absolutely incentivised to invest in these businesses. We need to upgrade ageing Western networks to cope with a changing energy construct – one that has moved from centralised production to diversified and decentralised production.

We are also looking at other parts of the decarbonisation story. We like the transport sector and the building sector. Transport is responsible for around 25 percent of CO2; buildings for around 12 percent. There is a huge amount of pressure to decarbonise. We are seeing this huge shift in terms of forcing people to buy electric vehicles (EVs). We do not have to bet on VW or Tesla. All these cars are going to have more semiconductors on them, because they are having to deal with electrification of the drive train, so we can own companies in that space instead. And within the building sector we know some chemical companies that are helping to reduce the carbon intensity of cement and making buildings more efficient by using membranes that go on roofs to make them more effective in reflecting or retaining heat.

Investors must not assume that obviously green industries are the only way to capitalise on the drive to transition to a low-carbon world.

To learn more about James Hambro & Partner’s approach to sustainable investing, contact Christopher Macklin – email CMacklin@jameshambro.com. Telephone: 020 3817 3401

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